Checking STI stock chart from yahoo, it says, STI almost bulled non-stop from the low in Mar 2009 until it reached the high in Nov 2010, bounced off somehow and almost touched the same level in Jul 2011. That was incredible. If it continues that way, we will be in wonderland very soon. So somehow, lot of negative events hit and dropped about 18% from its high.

Just by looking at charts alone, I would say the market is taking a break before going for new high. But well, people read news, and news sound worse than the market.

What will happen in 2012? I don’t know and try not to predict. Generally, valuation is not as depressed as compare to last crisis but neither does it look excessive.

Activities
I invest in Unit Trust using CPF money and despite so much noise, these investments ended the year at breakeven.

In 2011, I stepped into some of the worse regions and countries. Purchased quite abit of Europe and Japan. Beside that also purchased small amount of Singapore and Greater China. What is my plan for 2012? Well if the market keep going down, I will use up the available amount in my CPF (not much left actually) and just dump in any new money that flow into my CPF. But if the market goes flat, will buy bit by bit every 2 to 3 months. Nothing new actually.

Stock
2011 was a year of activities.

Sold out of Pfood after FY2010 results was out. Despite pricing at discount from Book, I have no idea when the low profitability earned by this industry will last. Especially after watching businesses in China from my little world, I am very negative on the way capacities are being add in all range of industries. Let see how it goes. Thankfully, I think I sold at around the high for the year.

Sold out of Full Apex and left with some odd lot. The industry and business is not doing well but I intended to hold because price is good. But I hate it when insider and minority shareholders keep “fighting”. That is a lose lose. I sold out once I know what Pope was doing. Thankfully, I think I sold at around the high for the year. Good luck hit twice.

Almost sold out of ARA Asset Management. Started in 2010 progressively until it reached about the high of the year at about $1.7. The decision was purely valuation. What left over are just for annual report. Or maybe just that I refuse to sell out for a good business.

Sold 1/3 of Sarin Technologies when it almost touched $1. Decision was purely valuation again.

Sold 50% of Food Empire when it reached the high of about $0.50 and sold out of it when it falls back to my purchase price. The decision was part valuation and part disappointment of the management and business. At $0.50 hit my sell price unless the business improves which it did not. Sold the rest at purchase price when I had better ideas.

Sold out of Banyan Tree at just below my purchase price. Reasons were mainly valuation as market was producing better ideas. Perhaps it was also my mistake to purchase it close to Book and did not sell it off then watching the it traded close to 1.5x Book.

Purchased Haw Par Corporation. Consisted of difference businesses if their stakes in UOL, UIC and UOB are considered. On the whole, these businesses range from average to good and managed by people who I consider at least average but conservative. It has been acknowledged that Haw Par Corp should trade at a discount to Book but it is this discount that I like. With these businesses and management, I can wait for a day when market decided that a discount is not required. If that day never come? The businesses and management should carry me over.

LHT Holdings Limited was purchased in a very difficult environment. Almost zero liquidity and a $0.005 to $0.01 change in price mean a big change in valuation. What more, a director has been sucking up what sellers were offering. After the wash out in the early 2000s, the industry should provide better return for remaining player which mean LHT Holdings Limited profitability will be better. But I am still negative about whether current profitability will be enough for future capex. Still there is one thing I believe is if LHT Holdings Limited unable to earn back Capex, the market will adjust itself. The next negative is their expansion into other countries. Oversea expansion doesn’t always mean growth; it can also mean new intense competition. And I doubt that after so many years of cutting and barely profitable and in one of the industry where ‘talent’ don’t like to work in, they have the right management to bring them forward. But well, an average(or even below average) business with very good price make the cut.

Starco Corporation Limited was purchased in a very difficult environment especially when I refused to pay anything more. Add in repurchase by the company. But this was also the only company that I pay above Book.

Hong Kong Land was purchased during the year. I have not read a single good country that is positive on property market. But then this is the period where company can be purchase on cheap. I might be early but I like this management and how it is being managed.

SC Global was purchased during the year. Two things that associated with SC Global will be government measures and high leverage plus unsold inventories. I have a different view. SC Global leverage is not high. The interest payment that worried me but this worry goes down when development reach TOP. Next debt to fund working capital is different from debt to fund Capex. Especially so for property developer. And let say current government measures work(more will be coming if it don’t), it will cause price to drop or at least flat. It will hit cost and revenues. In this industry, any player with access to low cost land will generate good profit. Completed unit is liquid. Better still if these units come from low cost land.

Increased in Asia Enterprises Holding during the year when price dropped. Business is still the same so the purchase was base purely on valuation.

Increased in YHI International during the year when price dropped. Businesses should be the same except that it is moving into direction that I don’t really like it. But I like the valuation better

Increased in Wheelock Properties during the year when price dropped. Despite all the noise on government measurement, business is still the same and valuation makes the cut.

Increased in TPV during the year. The industry suck and I don’t know what will happen 10 years down the road. But there are good indications going forward. Less change and weak players fall out. Hopefully it will go the way of LHT Holdings Limited. Valuation makes the cut.

Changed?
Maybe so maybe not.

I have been placing my bet on increasing stocks rather than concentrating on a few. Why is it so? I would like to think of it due to 2 reasons.

1st is due to increasing the pool of company that I watched. This might resulted in buying more companies.

2nd which I think is the more likely reason is valuation. Despite the dropped, good business with good management are not cheap at all. The best is just fairly reasonable. I think average and lousy companies are way cheaper. Many companies hit the price I would like to buy but it never goes free fall after that. So there is no way I would goes for concentration.

So what will happen if the market goes free fall in 2012? I will goes overdrive, leverage if need. Dump holdings and goes concentration.

Time line.
Annual Report 2008

- Energy Service segment was created and grossed US$29 million.
- Receivables at 87 million. About 118 days outstanding.
- Receivables past due 180 days = 7.5 million with 6.3 being impaired.

Annual Report 2009

- Energy Service segment renamed as Deepwater Subsea Services and grossed 46 million
- Receivables at 183 million. About 203 days outstanding.
- Receivables past due 180 days = 84 million with 2.7 being impaired.
- No additional impairment required but additional credit risk assessment being disclosed as Deepwater Subsea services had receivables of 75 million and 29 million outstanding as at balance sheet date.
- What was also disclosed was ” Included in the Group’s trade receivables of more than 120 days is a balance amounting to US$75,077,000 (2008: US$29,534,000), where the Group has the right to a permit held by the debtor to explore drilling activities in the territorial waters of New Zealand. The proceeds arising from realisation of this permit is expected to be in excess of the balance receivable.”

Annual Report 2010

- Deepwater Subsea Services grossed 21 million
- Receivables at 206 million. About 212 days.
- Receivables past due 180 days = 85 million with 4.5 million being impaired.
- Additional credit risk assessment being disclosed as Deepwater Subsea services had receivables of 88 million outstanding as at balance sheet date. Receivables due from New Zealand amount to 75 million for 2009 and 2010
- As at B/S date, Ezra collected 8 million out of 96 million of gross revenues from subsea services since 2008 which was 3 years.
- Included in the Group’s trade receivables of more than 365 days is a balance amounting to US$75,097,000 (2009: US$75,077,000), where the Group has the right to a permit held by the debtor to explore drilling activities in the territorial waters of New Zealand. The proceeds arising from realisation of this permit is expected to be in excess of the balance receivable. Accordingly, the balance has not impaired.

Annual report 2011

- Subsea Services grossed 180 million.
- Receivables at 302 million. About 197 days outstanding.
- Receivables past due 180 days = 95 million with 5.7 million being impaired.
- No additional impairment required but additional credit risk assessment being disclosed as Subsea Services had receivables of 170 million outstanding at balance sheet date. Receivables from New Zealand amount to 75 million.
- Included in the Group’s trade receivables of more than 365 days is a balance amounting to US$75,097,000 (2010: US$75,097,000), where the Group has the right to a permit held by the debtor to explore drilling activities in the territorial waters of New Zealand.
- In October 2011, the Group entered into a settlement agreement with the debtor in respect of the outstanding receivable to settle the amount in not more than five years. This amount is secured by rights and interests to the receivables of the debtor including participatory interests and guarantees. This includes an undertaking that the debtor has obtained from a private funding source to meet its repayment obligations.
- As at B/S date, Ezra collected 106 million of gross revenues from subsea services since 2008 which was 4 years.

Outstanding days of receivables at each B/S date were worse than rough gauge of Ezra receivables as these excluded revenues grossed from associates and joint venture. Ezra trade with these related parties as well and those were not small amount.

Other than that, annual reports of Ezra for last few years were also a bit special as they were disclosing more which is reasonable if not auditor was not doing the minimum requirement of their job.

But looking at information available, the party in New Zealand is clearing in default or without any mean of repaying. That goes against FRS in assessing the ability in repayment and whether to impair or not. By in agreement with Ezra that impairment is not required due to Ezra right in getting permit mean playing right at the line between right and wrong.

Which company policy allow the company to enter into settle agreement after more than 3 years of outstanding and give debtor another 5 years for them to find a way out?

Of course unless the company is in the same boat.

That 75 million is not small sum. It is 187% and 99% of FY2011 and FY2010 NPAT respectively.

Lastly, lets just say is it reasonable to expect more cockroaches in the cabinet when one is found.

The cost of operating an aquarium is pretty much fixed and when revenues crossed certain level, return will become great. It will not be fast growing but it will most likely to be very profitable growth. Out of the huge number of lost making aquariums in China, Straco owns two profitable aquariums. It acquired UWX few years back and turns out to be a smart buy. With it almost $80 million cash on hand, buying growth is easy but buying profitable assets is another story. Not everything is equal.

There is nothing much to analyse about the number except on the following
1) Fixed Assets – I have a strong feeling that Straco is under invest in itself
2) Expenses – This is an area where management can control.
3) Revenues – Telltail sign of profitability and the place to be for visitor
4) No sign of aggressive gunning for growth.

Haw Par Corporation Limited
I love aquarium business and I like Underwater World Singapore. It the same like SOA. But Underwater World Pattaya and Chengdu Oceanarium look like they belong to those lost making aquariums of China. Chengdu Oceanarium had ceased operation and I don’t know what will happen to Underwater World Pattaya.

Growths at healthcare and property division are not going to be fast as well. But these 3 divisions have produced exceptional profits over the years and unlikely to change in the future.

I was talking about putting cash to good use few months back. Of course I would love to get them back as dividends but from the way Haw Par is being managed, it is unlikely to happen. What is the next best thing? Roll the profit and Haw Par placed $20 million into AFS in last quarter. Good.

Haw Par remains an exception for me as I have not read UOB.

Asia Enterprises Holding Limited
3Q2011 results were exceptional? No!

Despite having increased revenues and profit in the quarter, it was just another quarter for Asia Enterprises. Looking quarter on quarter or quarter to quarter is as good as guessing the price of steel.

I try not to look at the movement in revenues and margins. That say I am perfectly comfortable with revenues dropped by half or Asia Enterprises making losses in any particular quarter. It will happen!

I look for things company can control -
1) Expenses – Operating in an industry that swing and hardly any growth, expenses count.
2) Inactive – Rather them be slow and old than aggressive and die.
3) Profitability – Over longer period profitability count and I am counting. So far it is so-so since Asia Enterprises wrote down the inventories.

Wheelock Properties (Singapore) Limited
Wrong timing!

I have been waiting. I knew revenues and profits will drop off the cliff in this year. Little did I know INT FRS 115 has moved the cliff to next year.

That market has been shaking for some time. Hoping for a bomb explosion from 3Q results but forgot about TOP dates.

There is nothing much to say about the number so what’s next? I don’t know but I want to buy more cheaply.

Sarin Technologies Limited
3Q results were good. Sarin is paying out more dividends and spending money.

Anything to analyse about the results? Not much except that these number reflect on those operating and corporate activities. Like
1) More dividends
2) Share buyback
3) R&D and acquisition of technologies
4) Capital expenditures

Is Sarin Technologies paying too much to buy back share at 70 to 80 cents per share? I don’t know.

I don’t know what the true valuation of this company is. I knew I paid too much for my initial purchases. And I knew it was incredible cheap when share price dropped below 30 cents and then 20 cents. Yes there were worries about the duration of the slump but with exception of prolong non existence of demand for their products, I did not need to know a lot to see the cheapness back then…

That was the easy part. Hopefully I will have the chance to experience it again.

The hard part is selling at what valuation. Unlike companies like Wheelock, Asia Enterprises, Haw Par and Straco I have a problem with selling Sarin at what kind of valuation. But whatever the real worth of Sarin is, I have always loved to sell something at 5 X BV.

Those sectors are
1) Housing
2) Energy
3) Healthcare
4) Agri business
5) Travel and tourism

Isn’t it good? Someone do the hard works for me and all I need to do is follow them, perhaps not everything but add some own thinking and magically I have the sectors of the next decade. But what if it doesn’t work out? Neither is they liable nor will still be here. It is just a report. And at current environment, not many will put their head on the chopping board and put forward sectors that is disliked by almost everyone at the moment.

So let’s play a game. I will try to come out with 5 sectors that are either hated/dislike, ignored or indifferent. And these will be my favorite sectors.

1) Technology/ manufacturing
They were the favorite at beginning of last decade but no one talk about them anymore. Except those that are related to the new social network. There are Venture Corp, Chip tester, HDD related, etc. Their outlook are dammed poor and is there any stock in this sector that trade above 2X NBV? I don’t know but I do know lot trading at below NBV. All they need is to be in an environment where some new growth, etc and it can easily become the sector of next decade. If growth is there, they will have additional tailwind – valuation expansion. Chip tester anyone?

2) Transportation
SIA, NOL, Comfortdelgro, etc but excluding anything that related to offshore sector. NOL is abit tricky as they went through a big bloom few years back. Anything related to bulk shipping might be a good bet of the decade due to current overcapacities in the industry.

Why is transportation? 2 simple reasons. 1st bet against energy either from reduction of energy price or energy price does not increase as fast as it use to be as compare to player able to pass the increase to customer. 2nd is over capacities reduce asset price which will benefit these players.

Betting on transportation is betting against favorite sector of DBS.

3) Retail and F&B outlets.
Retail properties have a great run for over 5 years. Thanks to REIT, Shopping Centre is 2011 is a big different from 2001. More will be built. Betting on Retail and F&B is a bet against retail properties and REIT. This is a bet against past and current favorite. A cyclical industry is still a cyclical industry no matter how it is packaged or how good it is performing now.

4) Consumer brand.
This is a bet against soft commodities price. High commodities price has cause lot of troubles for these group. Despite this better companies are still able to perform well in last 5 years or so. So guess what will happen if they are not pressure by raw materials anymore?

5) Finance / bank
There is a limitation of sector locally and since it is not part of their favorite sectors, why not companies in finance and banking. And the best thing is their stocks are not at particular expensive level.

It is really hard to come out with sectors locally especially when majority of them are currently undergoing some kind of tailwind or something like that. Majority of listed companies are in cyclical industries which is capital intensive. When times are good, everyone enjoy. New players come out of nowhere. What will happen next? Over capacities, intense competition, depressed profitability.

Where are they right now? I don’t know. In stock market, beside profitability, price plays a part too. But if I will to base on profitability alone, maybe the local Enterprise 50 and IPO might help.

Russo manages $4 billion as a partner at Gardner Russo & Gardner.

Tom Russo: That’s a warm welcome. Thank you so much. My focus – my field of investing is global value equities and I invest in a large number of spirits companies and so very often in meetings like this the spirits companies finish their presentations and say that they’re the last thing that stands between the audience and a nice drink and in this case I’m the last one between the audience and a See’s chocolate break.

As a global investor I would make one observation if you would just pull up your agenda of speakers you’ll look at Charles Brandes who really pioneered the field of global investing and he started in the mid 1960s and you’ll see how young he looks, and so I’d say there’s a lot to catching a tail wind, and his career has enjoyed the benefit of a tailwind and I came on the scene much later than he did but have also I think had a very good tail wind to my investment activity as a result of opening the investment universe which I ply to foreign stocks rather than just maintaining a purely domestic approach, as did the Sequoia Fund when I was there, and as did most of the fund managers in the early 1980s when I started after graduate school of business. I’m delighted to see this audience much expanded and I’m glad it’s back in Omaha rather than L.A. It’s a lot easier to get around.

I’m delighted it’s bigger because Bob does a great job. Over the years I’ve learned a lot of lessons from this conference. He’s had Kevin Clayton speak. He’s had the interaction that we’ve enjoyed from Berkshire’s subsidiary companies. So Kevin Clayton spoke one year and spoke about what it meant to be a manager within Berkshire. And he described how if there’s ever a question, usually a capital allocation question, Warren would offer to fly him up and it’d be a very simple process where he’d come and state the case. “What do you want to do Kevin?” And Kevin would state the case, and Warren would ask him three questions, and the first question Kevin would answer, and the second one he would answer, and before the third question was asked typically he said he knew the answer and he went away informed as to what the right outcome was. Now that role of Warren the business counselor is one that I don’t think is often enough described, and I think it keeps the capital allocation and really the focus of the company going along. Kevin gave that insight.

Bill Childs spoke some years back and he described something that’s part of so many of Berkshire’s businesses which is that though it’s a furniture business it’s really a financing business with secured lending against sofas and against the family spending power over the years. He also described something that probably cost me a lot of money. Much like Patrick Dorsey, I had invested in newspapers and he said that the greatest thing about his business is he has enough density in every market to advertise on newspapers and it just draws traffic like mad. So that was unfortunately a confirmation that I should stay a deep and broad investor in newspapers, for which I’ll take up issues with Bill if he’s still around.

Flight safety, Bob mentioned I learned that a simulator is indeed a simulator because I crashed badly both on take off and landing. In life, you only crash once. It was a simulator. And so, this year, we were going to have David Sokol and that would have been a great presentation because Warren’s always said according to Kevin Clayton that when people visit he sends them back with only one message. He said actually they visit the board regularly as members of the management team just to get a sense for how they’re doing in the hierarchy and the only two messages they get sent back with is build your competitive moat, about which he had discussions earlier, and don’t do anything to harm the reputation of Berkshire as expressed by front page news, and it seems like one of those lessons was well learned and we heard about it, but one I gather has been left unlearned.

Jack McDonald, who you mentioned, as my professor at business school said what you should do when you speak publicly is tell the audience what you’re going to say, say it, and then tell them what you didn’t say. So I’m going to talk about value investing and my goal is what is simply described as buying fifty-cent dollar bills. But I recognize a couple of things that Warren Buffett spoke to our business school class at Stanford Business School in 1982 that affect how I apply that that notion of the 50-cent dollar bill. And the first important point was that the government only gives you one break as an investor and that’s the non-taxation of unrealized gains and so you should probably build your investment practice in a way that you capture the benefit of that, which means you want to buy and hold for a very long time. And so if you just buy a fifty cent dollar bill and it doesn’t grow in value, your return is entirely dependent on when that discount closes and so if it closes quickly in the first year, you might make a 100 percent on your money, but if it takes 10 years for that discount to close it will be a 7 percent return and if it takes 20 years it will be a three and a half percent return.

Now the offset of that is if you find businesses that are undervalued but have the capacity for that dollar to grow, you’re much better off. In my particular expression, the other thing that Berkshire’s chairman said to us at Stanford Business School in 1982 was invest in an area that you like, where you’re invested in because you’ll probably work harder at it and know more about it be more intuitive about it. And for me that turned out to be food, beverage, tobacco and media. These are all businesses that have franchises in many of the same ways as Patrick described them, but those franchises are important, they give you pricing power. They tend to be global. So in my march abroad I was able to broaden my universe. If I were a beer investor, and looked beyond Coors and Budweiser and Miller at the time, to Heineken (HKHHF) and Asahi and Kiren and the whole complexion, to know the industry well you have to naturally look at the global competitor set because most of the businesses I invest in tend to be global. And so it’s been an important addition. Invest to take advantage of the non-taxation of unrealized gains and then to broaden the universe of the companies that I tend to focus on to be global because that’s just the natural competitor set.

Berkshire’s (BRK.A)(BRK.B) chairman said you’ll have a very few number of good ideas in your lifetime so pick wisely and invest for the long haul. And that’s sort of the notion. It’s hard to make that dollar bill grow, that’s the problem. And in public companies typically it’s the case that managements are not prepared to invest as fully as they could in pursuit of the growth of the dollar bill. So, buying a 50-cent dollar and then not having it grow is very costly, your capital runs out of return over time. So what I’ve looked for are businesses that for one reason or other are willing to invest hard behind the growth. And what that means is they have to have the capacity to suffer.

When you invest money to extend a business into new geographies or adjacent brands or into other areas, you typically don’t get an early return on this. And this is a very important lesson. The concept of the capacity to suffer I borrow from a response that Jean Marie Eveillard gave at a Columbia presentation when he was asked what are the characteristics of a good analyst – what are the characteristics of a good investor in some ways, and he didn’t miss a beat, he said the capacity to suffer. He said that he understood that because he grew up as a French Catholic, and the religion in France assured him that he had reasons to suffer for his life.

But the reality in the business world, it really does exist. As a money manager we have to have the ability to suffer through bad periods of performance and in my own history if you look at the year 1999 we were invested at that time in good businesses. We had Nestle (NSRGY). We had Heineken, Unilever (UL) – the whole host of companies I still own. They happened to be terribly out of favor relative to the forces that were driving the markets at the time. I was very lucky not to be forced by my investors to chase after what seemed to be generating such great returns. We were in fact in 1999 down 2 percent and the Dow was up 27, and then I think if you went into the early part of the next year, I think we may have been down 12 or 15 percent and the market may have been up again 30 percent. And you have to have the capacity to suffer when you’re going through a period like that.

For me, the reason why I was afforded the luxury was that I had built some trust with investors, I had built a lot of embedded gains to that they were kind of locked in by their embedded gains and I managed a very small part of most of my investors’ money. So I was able to allow them to enjoy the benefit of Cisco (CSCO) which rose to half a trillion market capitalization while we somewhat withered during that period. But we were able to stay the course. We had the ability to suffer. And we were able to then capture the benefit that arose. And in some funny way, having had such a massive underperformance in 1999 is what set up the portfolio that I manage the main partnership for the 10-year performance that you see through March of 2011. That outperformace is greater than I ever had in a prior 10-year period and I think it was in part because I was allowed to suffer through this missed performance.

Most public company managers worry about a year like 1999 and they may encounter one if they invest heavily behind a new project, they may show numbers that are unattractive and they worry about the loss of corporate control. In the 1980s, 1987, Gilette was in the midst of making a very long investment in something called the Mach 1, and at the tail end of it, Ron Pearlman came along and lobbed a takeover offer and it was in part received by the shareholders because they were exhausted by years of seemingly dull performance that were really decent performance in the core business masked by the investment spending that occurred to develop the new project. It’s rare that companies are willing and able to step up and make the full investment.

I think this is a lesson not in the global sphere but in the Omaha sphere that I’ve learned the best from Warren Buffett. If you look at his investment behind the equity index put option business which he took on just several years ago, well he received an enormous amount of premium for ensure against the decline in global equities. But he had a very long duration and he had no collateral posting requirement and there are all sorts of interesting things he can do with $5 billion dollars given his position and the time the money came in. But the one thing he had to do was he had to be willing as a result of that investment was he had to suffer enormous hits to his reported profits. And I think one of the reasons he received as much premiums as he did in that transaction was because very few people would compete for him on that business. Because who else wants to see the reported profits collapse or who else wants to have a minus 2 percent year when the Dow says it’s up 27?

It’s hard to be out of step and it’s a rare company that can do that. He did the same thing when he grew Geico from the point where he acquired it. And he told management at Geico just to grow the business even though every new policy holder that was put on the books cost an enormous amount of losses the first year. They had high net present values and you’ve seen the history I think the number insured at Geico because of Berkshire’s willingness to show the losses up front have grown from just under a million policy holders to almost 10 million and his spending to drive that growth that just burdens operating income up front has grown from $30 million a year to almost $900 million. And you know that it’s the case because the only advertisement on television is a Geico advertisement of one shape or another. But the fact is by spending up front, having the elasticity the willingness to burden your income statement and then getting the results in the future is a very nice trade off.

The last thing he did was he kept $50 billion in cash and he still has enormous holdings in cash and if you listen to him speak about it it basically comes to us at sort of .2 percent returns at the moment. Now that’s the capacity to suffer because he could extend the terms and get sort of 4 or 5 percent some place if he chose to but clearly he would risk our wealth if he were willing to chase reported profits. Berkshire did this throughout the 1990s – excuse me the period of the mid 2000 and beyond and bore the suffering of low returns of that money and it was just the opposite of what most American companies did. I think someone asked the question about what lessons were learned as a result the crash. One of the things that almost all American companies had done by the time 2008 came around, was they had taken their entire borrowings and brought them into the short-term overnight commercial paper market. And in so doing they took high interest rate long-term money and they took it down to overnight money, just the same Warren was making on that short term paper, they were gracing their reported profits by overstating them, by shortening the borrowing period. And the whole country got caught in that trade other than Warren. A perfect example is GE (GE), who had $100 billion of overnight money had to come to Berkshire and say we’ll pay you 10-plus for $5 billion, whatever the number was. Goldman Sachs had the same problem. And it was really the willingness of Berkshire to suffer through periods of understated profits that put them in such a powerful position when the crisis occurred. A crisis that came about as you seek most public companies are just the opposite. They take risks with their future, and then they overstate their short term results.

It’s a very rare business that has the capacity to look beyond. One of the things Warren said to our business class in 1982 which I thought was most profound had to do with agency costs. And he said basically you can’t make good deals with bad people. In terms of the investment business that means you have to be very careful of who the agents are who are investing your capital. And if I said at the very start that my client’s aim is to own businesses for a long time to defer taxes, and at the same time it’s to grow that dollar in value, I have to be very careful of which management teams I select to then reinvest our money to make sure they do it with Buffett-like eye toward future growth rather than the conventional focus on short-term profits.

One of the ways that I’ve come around that challenge is to favor family-controlled companies. And so really since the 1980s there’s been a vast preponderance of family-controlled companies in my portfolios. And that actually has two benefits. One is that family-controlled companies are often undervalued. Because the image of a rapacious families that steal from shareholders is so vivid. We saw it with Delphi in the U.S. We saw it – that’s probably a good example. So that ability for poorly – well Enron wasn’t family controlled – but when you have a business that has the ability to self-deal because of the family-ownership structure and a controlled board, you’re at a risk and so people typically paint too wide a perimeter around family-run companies and they don’t pay enough for the value that comes from a company that’s properly managed where the family’s looking out for the long term.

So I think that that combination of looking for 50-cent dollars, looking for them where they can reinvest to grow, and then who’s going to reinvest it? They better be able to suffer because proper investment requires that.

One of the examples that came to mind in the global sphere is Charles Schultz, the chairman of Starbucks (SBUX), who several years back spoke to investors, and there was one nettlesome young analyst who kept asking the head of Starbucks when they would show profits in China. And the dialogue went back and forth: When will you show profits? He said, how big do you want us to be? When will you show profits? How big do you want us to be? And it went back and forth like this. And the answer was – and I think it’s the true one – if you want us to dominate China, then let us not show profits for a long time. And if you permit that, we will end up at the final analysis with a dominant position in an important market with moat-like characteristics. If you try to establish, as so many American companies did, a base in China and do it without impacting earnings, you’ll do it with a very small business that won’t have a competitive franchise. And that trade off is just as clear an expression of this notion of the capacity to suffer. Now Schultz isn’t going to lose Starbucks because he has enough stock to keep it on the course that he chooses, but there are many companies that don’t have that control, most don’t, and so they favor short-term results versus the long term.

And the last thing I guess I’d say, there were several questions about what’s a competitive moat and what’s the method you use to decide whether something is worth a dollar in the first place? I look for 50-cent dollars, but what is a dollar? And for me, it would be a business as a franchise and a business that has the capacity to reinvest money. A perfect example of that would be Nestle, where they’ve been in foreign markets for over 100 years, where their products have been in the consumer’s awareness, but they’ve been unaffordable, because that broad consumer doesn’t have the consumer disposable income. But that awareness and that pent up demand is really an asset that is largely missed when looking at a company. You think about the difference between Kraft (KFT) who Patrick said has suffered badly in its domestic cheese business, and a Nestle where they have a share of the consumer’s mindset in 135 markets I think around the world. Kraft struggles mightily because of the domestic nature of their business and Nestle has the capacity to reinvest money broadly around the world and in an accelerated fashion because the world is growing in its consumer disposable income. An so I would look in general to the ability in the growing foreign markets as a source of what I think has over the years been a very important contributor to the performance you see on this table. From the early 1980s we’ve tapped into businesses that have had the capacity to reinvest abroad. And that’s been a huge part of the business success.

Remarkably in something like Nestle’s case I think it’s grown just below 15 percent total shareholder return for the past 18 years, and I actually think today it’s more promising looking out than it was when we started 18 years ago. And that’s because of the addressable market that they now tap into allowing them to direct capital at an ever greater pace to expand their franchise and to build on the latent demand for their products.

Let’s take a look at the start here. This is just a quick and fun – being a long-term investor, really means that you have to stay the course very often and I use this because at one point, just before the crash of 2008, I was in Africa and we went on safari and we saw dozens of animals and every time we would see one the tour guide would say, if you ever get separated from the group and you see this animal – there was a hippo or a lion or whether it was any number of things, small animal – and it charges you, stay put, don’t run, stiffen up and it will not harm you, it will run past you. And that advice again and again and again, we saw dozens and dozens of animals. We came up to this one, it was a cape buffalo, and he said, and if you’re ever separated from the group and you see one of these things and it comes charging at you, run like hell.

And the good thing about that is it kind of gives you a sense of what it’s like to be a portfolio manager. You know, we’re supposed to hold for the long term, and then comes along 2008 and you never know from a distance until it’s right on top of you whether it’s a water buffalo or whether it’s something else coming at you. This is what I refer to when I say it’s all about the future. It’s about, you know, what Warren said at the annual meeting a couple of years ago: Investing is as simple as this rule. It’s as simple as this and it’s as hard as this at the same time. Because you don’t know how many you’ll end up with in the future and you don’t know when they’ll come. And it’s fairly simple, but it’s hard getting the culture right of the companies.

And the culture of Nestle which is a firm that I have nearly 11% of our funds in, was described by the former CFO of Nestle and the head of Japan at one time, by reference to this building. He described it as a 750-year-old temple. And he said, none of the wood is 750 years old because it’s been refreshed and replaced over time because it rots and it has to be fixed up and replaced and but he said the temple’s 750 years old and that has to do with regenerating a culture and keeping a culture going in a way that hopefully is owner-minded and that’s really the hardest thing to know, whether a culture is owner-minded, and there’s just so many cases in public companies that it’s just not so, that it’s rare to find it.

So in the case of Nestle the appeal is this brand portfolio, and these brands are familiar, trusted and already ubiquitous globally. When I visited our South African breweries operations in the remotest part of Angola and you go to a village, which is an extremely undeveloped part of the country, you will see any number – you’ll probably see Maggi will certainly be there; Carnation will be there; depending on how advanced the country is you’ll have this milk product called NAN. But it’s there, it’s available and what Nestle is waiting for as are the other global companies that we have, is they’re waiting for the company to have migration and GDP from the left to the right, so as the countries move up the scale in terms of development then they have more money to spend, so you’ll draw people out from subsistence level living – where they’re providing for their own needs and nothing’s really processed – to processed products which Nestle can start participating in and then process branded and then process branded with a higher price and higher prestige, until the very far right upper corner where we become aspirational.

But this process is under way in parts of the world that are probably 2 and a half or 3 billion more in total numbers of people than 20 years ago. And that’s really what I try to tap into through the global companies that we’ve invested in.

It’s an interesting thing that consumer disposable income at the start grows much faster than GDP, because what you’re seeing in the markets that are just developing is you’re seeing people who are coming into the workplace for the first time. And so in India today there’s still over 500 million people living outside of the urban area. They’re still largely in the age of subsistence farming. But as GDP grows, they’re pulled from that level of existence into a monetized relationship with someone. That someone today typically – from the parts of the world that we trade in – is typically Chinese in some fashion or another. So if it’s in Africa today it’s going to be some form of Chinese company that’s developing something in their great reach for resources, and they’ll build roads and they’ll do any number of things, and they’ll bring people into the economy, and those people with cash for the first time, start to have disposable income.

And our job in meeting with the managements of the public companies that we meet with in the foreign markets is to make sure that they’re spending enough money. Are they willing to spending enough to build in advance of demand? Nestle recently announced that they’re taking their spending and developing of emerging markets up from a billion dollars a year to $2.5 billion a year. And anecdotally as they describe certain markets like India, where their results recently reported results were up 26 percent for 2010. It’s a big market for them and already the growth rate is accelerating in that market for them. Or a market like Nigeria where they have such a large business for this Maggi. If you’ll look here, the Maggi culinary business that’s the second largest market in the world for Maggi and they’re basically sold in one cube at a time but they become a part of the diet. And they’ve tripled the amount of business over the last decade for Maggi in Nigeria and they plan to invest behind another tripling over the next decade.

And people often say about Nestle, gosh, what’s the hidden value? Because as a value investor the allegation is that somehow you’re seeing value that there’s some trick. In Nestle’s case they had $40 billion dollars in holdings in a company called Alcon which they’ve now monetized and that money now sits on their balance sheet waiting to make investments. They have a third of L’Oreal, the French cosmetic company. And so the question is always is the cash the hidden value? Is the holding of L’Oreal the hidden value? How is the hidden value going to surface? And really the hidden value in Nestle is the capacity to reinvest. It’s the brands that they’ve got and it’s the awareness behind the brands, and it’s the willingness to invest even when it hurts. Nespresso, which is now a $3 billion brand, if you look there it’s still growing at 20 percent. That’s a very serious business, and it has yet to tap into markets like North America. It’s still largely France, Switzerland, Germany. But has the capacity to grow enormously.

Nestle has invested even when it hurts. During the Russian ruble crisis, for example, anybody who did business in Russia with imported products had no business at all because the currency crisis prevented dollar-based commerce. When Russia plunged, Nestle went back into the market and doubled down. They built facilities; they made acquisitions; they continued t invest in marketing. The belief was the market had the capacity to absorb the investment, and at the time, if you think about it, at a time of massive crisis you get a lot more done. It’s cheaper to build because there’s a lot of spare capacity. Nobody’s working. You can make a lot of meaningful advance. Today they have the benefit of a $2 billion-a-year business in Russia, and many people fled Russia at that time because they wanted to protect their income statement. In fact, ironically, L’Oreal, their partner, the company in which they have a third stake, left Russia at that time because they didn’t want to show their reported losses, that would have come from continuing to build their business during the downturn.

Nespresso – Inside Nestle they all described that Nespresso was almost canceled a dozen times. Because the only thing it did from the start was consume expenses. I actually went to a Nespresso tasting lab maybe eight years ago when I visited Vevey [Switzerland], and there were five scientists sitting around; they were all wired up with electrodes in their nose, to sort of sniff coffee, and I looked, and it was just extraordinarily painful watching them sit around and talk about whether they had pronated or whatever they were doing. And I told the people there that while they sat and worried about the taste of the coffee, Starbucks had opened up five stores and they were moving along. The fact is they really invested hard behind it and they got it right and now it’s a $3 billion business growing at 20%. But they suffered through that. And it all has worked out well for them. They had the capacity to suffer through it.

Another company I’d look at that did much the same thing was called Pernod Ricard (PDRDF). I’ve invested in spirits companies since the early 1980s, and Pernod was a family-controlled company, just like Brown Foreman is family-controlled. And they have been able to take bold steps over the years to expand their portfolio. They started with a French anise-based product, which is very cash generative but it’s not growing at all. And over the years they’ve taken bold steps. And one that really transformed the business in the year 2000, China, which by the way is a market of 500 million cases of spirits. That’s the addressable market. In the year 2000 the imported market was about 1 million cases, out of 500 million. And it favored Diageo at the time. And at that time it went through an early crisis of its own, and Diageo pulled out of the country effectively in the year 2000, having had the leadership position. Because there was no prospects of making money for quite a while there. Pernod Ricard – by the way, Diageo was being a perfectly publicly controlled company where they promised shareholders quarterly results, where they worried about failing to deliver against those results, and where they mined heavily the possibility of investment spending that might cost the income statement.

So, along comes Pernod Ricard, who had family ownership. They looked at the market, thought that a half a billion cases was a pretty attractive thing to shoot for. They went into the market, and today they dominate the spirits business in China. So it was a very painful period of time, burdened with a lot of operating losses during the start up, because it was a time when China’s economy was soft. But the addressable market was huge, and the result of that is they now have over 50% of the import market, which even today is only 5 million cases, still 1%.

One that awaits is further advancing of the general economy and spending power of the Chinese and there’s so many evidences of where that’s surfacing that I’m quite comfortable that the willingness to suffer that they evidence is going to be extremely rewarding to us.

It wasn’t an easy investment. If you look at during 2009 they stepped forward again and bought Absolut, which was a business that they came to terms on the acquisition in late 2008, and in response to a question was asked earlier – what did you learn during the crisis? – I had four companies which all entered into fairly sizable transactions. Heineken bought Scottish and Newcastle beverages; Pernod Ricard acquired Absolute; Altria (MO) bought UST; and all of them, all three of those companies, left the funding of their acquisitions open. So they were exposed to the financial crisis that occurred in 2008.

In the case of Pernod Ricard you can see what happened to their default credit swaps as a result of the market’s apparent glee that this deal would be unfinancable and that Pernod Ricard would suffer a financing crisis. It was about at the peak here, if you look at the top, that I started to get calls from my short-selling friends asking me whether I knew just how troubled Pernod was, and by the way, they wouldn’t be able to finance the deal, and by the way, it was the number-one shorted stock of the Euro 100 and it was 6% of my portfolio. So, that was one of my mea culpas.

But the fact is they were able to sell a brand called Wild Turkey and raise almost $1 billion, and they did a rights offering with the family and family-related accounts where the family then put more money back into the company because they believed in it. And that financing raised another $1 billion, and within this course of just a couple of months there they were able to stave off the financing crisis. And today they have what they believed they needed in the first place which was a vodka to accompany their leading Martel cognac, their leading Chivas Scotch whiskey business. So Absolut, which everybody here would agree, is a business that has certainly lost its luster, is a business that around the world has an enormous capacity to fill into their portfolio and to receive the benefit of their distribution. So it’s a business that has recovered in the equity markets and yet they’re willing to take the risk and suffer for the future, and they could do it, unlike Diageo, because they didn’t have the burden of fickle, public shareholders.

Last company is SABMiller (SMBRY). SABMiller has grown from the South African roots to the second largest brewery enterprise in the world. They have the largest beer brand in China, through a partnership with China resources. They dominate sub-Saharan Africa, which has been a part of the world that’s been entirely neglected. Today it’s a place where they’re directing an enormous amount of their capital. And that has to do with the sort of growth in Africa as a region economically. But if you look here, they have spent $500 million last year on Asia and Africa; they spent $250 million in the prior three years. And what you see has happened during this period of time, is the volumes in those markets have grown, the revenue has grown, but the EBIT margin, the EBITA margin in this case, has dropped sharply. That’s a measure of the capacity to suffer. I mean the reason why that’s happening is because they’re putting out capacity that when it launches doesn’t operate with peak efficiency, and knowing that building those markets, getting the brand in front of the consumer, will have long-term returns. They’re willing to invest against that, even at the expense of margins. It’s the one thing that I look at in the culture of the companies that we involve ourselves with.

By again the size of the addressable market, sub-Saharan Africans drink 400 million barrels of beer-like substances, but only 90 million of that are processed beers in bottles, in bottles, the rest is sorghum-based home-made beer. It’s not taxed, it’s not particularly well cared-for, it doesn’t taste good, and over time it will convert with the rising GDP and the disposable income of Africa. There’ll be a conversion from this old-fashioned traditional mix, to a proper beer. And so what SAB’s in the process of doing now is building capacity against that likely demand, and they’re spending an enormous amount of money now, at the expense of reported profits. Because it’s expensive to develop new capacity.

As a global investor, a couple of questions that come up and have come up since I started investing abroad in the early 1980s. The first question was, what about currency risk? At the time, having been in business and law school, I had a healthy dose of skepticism about what the rule of law means in North America. We often hold it forth as something that protects us and secures our business interest. But it’s also the source of enormous entitlements, and enormous amounts of money that gets spent in nonproductive ways. That’s part of our system, and my concern as an investor in North America was always to be less exposed to a currency that was once illustrious. And over the course of the decades that we’ve invested abroad, you can see here these marked years that currency has played an important part in our return. It’s given us about half a percent per annum for 20 something years, in terms of being a tailwind. We didn’t invest abroad just to assume currency gains, but over time, and I think continuing so, I think the parts of the world that are more productive, hard-working, energetic, will see rising currencies, we’ll get the benefits of those as the profits from those parts of the world are translated back to ultimately back to dollars, which will give us as investors, through these companies more spending power.

The other questions I’ve been asked as a global investor would include things like accounting, how can you trust the accounting? Well this is more an ancient concern. But when we first bought Nestle in the late 1980s, they sent out a three- or four-page semi-annual letter to investors that basically said, “Things are fine.” That’s it. Didn’t say a lot more. But they were. And that was sufficient for me. But today things are much more Western-like, and there’s more conformity. But the greatest crises have been American accounting-based over that period of time, so, I’ve been perfectly comfortable with the accounting, but that was initially if you can imagine, the sort of thing that kept people from moving their capital around.

Last observation I say is capital today still remains very trapped. I think of two companies in which we have investments, one is BAT, which is British American Tobacco, and one of them is Philip Morris (PM). They both are global tobacco companies, neither of whom directly operate in North America because of fears over litigation. In the case of Philip Morris, only 6% of their shares are held outside the United States. So it gives you a sense. It’s extraordinary. They have 100% of their business non-U.S., but because it’s incorporated in the U.S. for tax purposes, though based in Switzerland, the foreign market just doesn’t touch it. So we still have the benefit, by having a global perspective. We can buy BAT, we can buy Philip Morris, but if 94% of foreign money doesn’t desire to look at Philip Morris because it has a U.S. listing and we can buy the global non-U.S. tobacco leader at a price that doesn’t reflect its fair value because of silo-ed capital, we’re still given a bit of an advantage for having a global perspective.

Fifty-cent dollar bills: Make sure the dollar grows. How do you guarantee it to grow? Well you probably want to tap into international because that’s where the money is, that’s where the population growth is. Then you probably have to make sure that the company management, who control the reinvestment to secure that growth, thinks about owners and not quarterly profits, and has the capacity to suffer to in pursuit of that long-term wealth. So, that’s really what I do for a living. Any questions?

Question: Given the spaces you’re interested in, have typically acquisitive management teams, how do you stomach some of that… [garble]

Russo: In the case of an Absolut, one of the things that guides me, is the family is spending their money. It’s just fundamentally different. The prices are – in doing so they had to spend against public companies that have less – they’re less grounded in owner mindedness because they’re competing against the whole universe of possible buyers plus private equity as well. But, you know, Patrick Richard doesn’t want to overpay. It’s his money. He ended up ponying up more money for this transaction because the financing crisis then ensued. I use the internal discipline that comes from having a shared affinity as one of the guides. In this case, you know, they have some extraordinary number of markets where they have less than 3 or 4 percent market share. And that’s because in its prior life it was managed by a consortium of companies, none of whom particularly cared about distributing Absolut. And so it was just kind of introduced into the markets around the world begrudgingly. With the strength of the Pernod Richard distribution, it should have a nonlinear jump as they get the distribution and move it through their systems, save the money that they used to pay that third-party agent, and it could look a bit like what Patrick showed for Mastercard’s (MA) numbers. It looked like a full price, but if they get it into their system, and move it like I think they’re capable of doing, I suspect what they claimed when they bought it – that they could take a 10 million-case business into a 20 million-case business over a decade – has a chance of occurring, and that will more than amply reward us as investors. But the heart of it is that the family-controlled businesses are spending their own money. And that’s a parallel interest that I rely on. Yep, Patrick?

Question: I know it’s very hard to generalize, but as someone who has spent a long time studying consumer behavior, outside the U.S., are there any generalizations you can make about the propensity to spend more on grants, spend less, brand loyalty, cross culturally in different parts of the world?

Russo: Well there are a couple of interesting observations. These are quirky. In Japan, for some reason, there’s no brand loyalty. It’s a lockstep market. And Kirin Ichiban will be the brand of choice for just about that long, and then Asahi will come along with something called – aren’t there Japanese people here? Maybe you can help me out. What is it? Happo-shu, or something that they came out with? Which is a lower-cost new beer category. And now the entire market switched. But it’s just like this: It goes 40% market share to 5, from 5 to 40. It’s so unusual. That’s very quirky.

Luxury goods – really, there’s just a different relationship with them in Japan and China than in the U.S. For example, the head of Richemont would say the North American market remains still relatively Calvinistic. And you know, how many American men in this audience have more than two watches? And you all have Latin blood or something. Johann Rupert would tell you, that American men don’t invest in their own luxuries in North America. In Europe it’s very common to have six or seven watches. And in China, we hope it’s the same. We know that up until now they’re spending a lot on them.

And the desire to possess things of, sort of positional goods, the things that mark… but positional goods are a really high-order global story. Just how they express – I said to you afterward, to your question about the growth in private label, it’s an important question for me, since most of my portfolio is branded. You know I could show you what the names are actually, and you’ll get a sense. Those are the companies in which we invest. And this shows the developed market exposure, the emerging markets exposure, and how we get a composite 30% exposure to the emerging markets through this universe of seemingly developed market companies. But private label, I think you could very clearly see private label products crop up in categories, and get enormous adoption in North America as we struggle financially and certainly in Western Europe, Germany being an example in the lead there. And at the same time have those products be very aspirational in the parts of the world where the demand’s going to grow. So we have two worlds in some ways, and I’m comfortable with that. I think the private label is still a threat. And yet I think there are parts of the world where people celebrate the sheer act of buying their first can of Coke. Yep?

Question: In which products is private label more of a risk?

Russo: Um, the risk – I’ll answer the question what companies and then what managements will allow, in some ways, their products to go private label. Depends on innovation. Depends on marketing. And it depends on relationships with the customer. If they can keep the customer focused on their product by giving them enough product news to draw traffic to the retail. And give them some margin in it. Because they’re innovating with attributes that the consumer will pay up for. The customer won’t be given a reason to look elsewhere. They don’t have to look elsewhere. If they can get a proper flow of innovation, branding, and then margin from the manufacturer of the brands, they don’t have to go anywhere else. The consumer will pay up if they feel like they’re getting value for it.

A colossal mistake I think was the set of circumstances surrounding Procter & Gamble (PG) when Bob McDonald took over. A.G. Lafley defined this virtuous cycle about innovation – consumer inside innovation, rapid speed to market, high margin to the customer, advertising to express the arrival of products that are needed. And then during the downturn, Wall Street said, you know, it’s not going to work, the private label’s going to kill Procter. It’s going to kill it. They have to respond. And A.G. said no. And Bob McDonald said I can do that. *Swoosh*. A.G.’s out, Bob McDonald’s in. and they came out with some low-brand Tide, but this is not working. It’s not where Tide’s supposed to go with its brand. Tide’s supposed to innovate and then draw the consumer up, and then constantly close down the low end. But they took it thinking they needed to compete with private label. I think they made a strategic error there. Yes?

Question: Out of curiosity, you mentioned a couple European names, what is your view on LVMH [Moet Hennessy Louis Vuitton] (LVMUY)?

Russo: It’s just a terrific collection of assets. I haven’t owned it. And it’s been in part – I just haven’t felt as comfortable with the family that controls it, as I have with Johann Rupert and the way he’s treated outside shareholders at Richemont. And then I’m not so sure that they’re as long-term brand stewards as are the people who run some of the other businesses in the industry.

I’ll give you an example. They had this wonderful advertising campaign for LVMH Luggage, which showed this woman sort of stitching, hand stitching, a LVMH bag, and it had all the aura of history and luxury. And their competitors called them on it. And said, you don’t do that. You don’t do that. You glue it on. And you don’t stitch. You’re misrepresenting it. So they were taken to court on deceptive marketing practices and they had to pull the ad.

[Question 2]: But would they acquire Hermes?

Russo: Oh they’d love to get Hermes. But the fact is, they don’t do that. They don’t invest in the time and the care to deliver the brands that they suggest they do. And that’s usually a sign of something amiss. Short term versus long term. I don’t think that over time if people thought they’re buying stitched and it’s really glued that they’ll be building brand equity in the process.

Question: What advice do you have for an emerging market value investor who we don’t have a decade of years of relationship building with investors before you, like in 1999 in managing new investors as they come in?

Russo: Great question. I just don’t know what to say. Because if you invest in India, you would have seen the market go down 70% one year and back up 70% one year. And I think it’s very, very difficult to make sure the investors don’t do the wrong thing on both sides, you know, that they don’t sell after being beaten down and don’t buy only after the markets have come soaring back.

You could use a lock up. Or you could go with private equity. Private equity doesn’t have a quote, so you’re allowed to build the business under the quiet lack of transparency that comes with your own mark. And then lock up can help you as well. Over time I think it works, but you’ve got this enormous human element there. Yes, Paul?

Question: I’m just curious, Tom, your portfolios – do you have any investments in China or India directly as opposed to participating through other companies, and why if you do or if not?

Russo: It’s a great question, and we will. We will have direct investments in China. I’m going to go in two weeks to see Diageo (DEO). And by the way I mentioned that Diageo left China, and opened up the market for Pernod Richard, and I think they’d agree with that. I still own Diageo. You know, as an investor you’re not given 100% perfection when you choose between your investments. And Diageo is itself a great company. Terrific brands, they have great global reach and all the rest, they just blinked at the wrong time in China. Now maybe they’ll learn the lesson and maybe they’ll promise less smooth and steady results. But I’m going to go visit with them in China. While I’m there, I’m going to meet with a company called Hengdeli, which does luxury watches and jewelry in China. Whole bunch of Chinese companies will be part of the visit. And someday we’ll be able to invest in one.

I met with the CEO of Nestle recently and I asked him why Bright Foods has turned out to be the bride’s maid and never the bride. I should use that today because of the royal wedding. But he said just wait, because he’s now seeing globally competitive companies based on technology and branding and manufacturing in China, and I should just stay tuned, and Bright Foods is a great business he said. And just last week they bought a 60% stake in one of the companies that had been making them on contract basis their Nescafe in China, and they paid up almost $1 billion. Now they have $35 billion to spend at Nestle because of the proceeds from the sale of Alcon company. So they have to do a lot of deals like that.

I met with Johann Rupert who runs Richemont (CFR) in June of 08 when I was on that safari trip – he’s based in South Africa – and we were talking about Richemont, he said, the beauty of Richemont is we don’t have to make investments anywhere, we can just make them where the best returns arise. And he said, for example, then he was putting absolutely no more money into Japan, which had been 15% of their profits, because it was so badly ex growth, with the declining population, no immigration, problem economy. And it’s a beautiful response because he as a multinational, global franchise can put the money just where it has its highest prospective returns. He’s pouring money into China now. But sometime the returns in our lifetime may even go down in China. I’m not sure it will ever happen. It’s a big country and it’s a growing prosperity one. But the beauty for Richemont is that they can move the money all around. If I invest in a Chinese-only company, up until the present case, I don’t think they have the reach globally. You’ve got Lenovo. You’ve got Haier, and a couple of them, but they’re not businesses I particularly want to go into. I’m not sure yet we’re at a point where a business in the field that I’m focused on has the global reach.

And then the other thing is there’s just different ethics. In my field there are probably half a dozen incidences a year where local Chinese manufacturers of baby powder tainted with melamine and kids die. And that shows that there’s a pressure in the emerging markets to kind of make it fast, that’s different for someone that wants to invest with a really long-term horizon. Those are segregated incidences and it’s not true of the whole country, but it happens more frequently than you’d like to see. And that’s just the nature of a fast-developing economy.

How do i read? It is easy, I will start with earliest available information which is usually an IPO prospectus or annual report. Read all the way until the last available annual report then go through last few quarterly report and some research reports I saved earlier. The whole process usually takes about 1 to 3 weeks, depend on size and complexity of the company and my timing. My estimate is that I look into 10 to 20 companies per year.

But you don’t buy 10 to 20 companies per year. That is right. I don’t read them after I want to buy the stock. I read it before. At time without ever look at the share price. Not until I have finish it. Then I will ask myself those same old questions. Will I buy the share? At what price?

But that is a prefect example. Most of the time, I already know the price before or even during my reading. It is not good at all so I usually just dump the company aside as long as the valuation is not dirt cheap and pick it up later.

Why would I do that? It is because I don’t want to do stupid thing. That why I keep reading new company with no intention of buying any. I don’t want to be anchored by 2 things. Price and company. If I know the price is cheap before I started, the whole reading process is to reinforce the buy signal and ignoring signs of nonconfirmation. That is the same for company, I mean better company. All I will do is to search for things that tell me how good is the company and ignoring the rest. I am trying to avoid that, but I do not want to think about what kind of process and thinking I had before I make all my purchase. It will be ugly but hopefully I had minimise it

I do ratio or rather use spreadsheet to do ratio. I spend little time on it. Ratio on spreadsheet is useful only because my memory is lousy. I will not remember details of past 5 years performance of say Boustead Singapore one year down the road. That is when ratio and spreadsheet is helpful and they are over-rated.

You don’t use it analyse the company. You don’t understand the company if you use ratio to analyse. Read the financial statements to understand and analyse the company.

Boustead Singapore is a good example. I have not finished it but it has at least 2, if not 3 different kind of businesses in it. Ratio does not tell the story at FY2006 & FY2007. It does not say the star player in Boustead Singapore is ERSI and the kind of competitive advantage it enjoy. Neither does it say about maneuvers that created those results.

Boustead Singapore is quite interesting because it require quite a bit of skill to understand the company and I believe it has been highlighted before by CEO. But the key is able to know it by reading the number and I would bet many don’t.

Those who know are the ones that spend load of time doing the same thing over and over again. Reading annual reports. That is what I am doing and intent to keep doing. I only know the valuable of reading annual reports until I read lot of it.

I am please that men without character have lost.

Post election – Window and mirror

look in the mirror to take credit for success, but out the window to assign blame for disappointing results.

look out the window to attribute success to factors outside themselves, [and] when things go poorly, they look in the mirror and blame themselves

European bank stocks swoon to 29-month low
Fri Aug 19, 2011 6:44am EDT

* Bank stocks break below last week’s lows, resume slump

* Chart shows sector oversold, but no turnaround in sight

* Europe banks much cheaper than Egyptian banks

By Blaise Robinson and Christian Plumb

PARIS, Aug 19 (Reuters) – European banking shares swooned to their lowest level in nearly 29 months on Friday, led by Italy’s Intesa SanPaolo on concern about the lenders’ ability to fund themselves amid a worsening economic slowdown.

Intesa tumbled 6 percent, while Raiffeisen Bank dropped 5 percent and Societe Generale and UniCredit — among top decliners in recent sessions — also sank, down 3.3 percent and 4.2 percent respectively.

The sector index , stuck in six-month downward trend in which it has plummeted more than 40 percent, broke below last week’s low and hit its lowest level since the heat of the financial crisis in April 2009.

“The market fears liquidity problems for the banks following the rise in overnight loans from the European Central Bank earlier this week. We’re getting more and more signals pointing towards the spectre of the interbank crisis of 2008,” said Sebastien Barthelemi, credit analyst at Louis Capital Markets, in Paris.

Earlier this week, data showed the ECB dollar operation was used for the first time since February, with a single euro zone bank borrowing $500 million of the one-week dollars at a fixed interest rate of 1.1 percent, well above the rates that trusted banks can get dollars for on open markets.

Data from the ECB showed on Friday that 107 million euros ($153 million) were borrowed from its overnight loan facility in the past 24 hours, down from 212 million euros the day before.

A banking analyst, speaking on condition of anonymity, said funding worries are weighing on the banks, as are wider worries about a potential double dip recession.

OVERSOLD, BUT NO TURNAROUND IN SIGHT

“The market is falling and banks are seen as very risky,” he said. “It’s funding concerns, it’s a new recession, it’s investment banking revenue trends and there are concerns over earnings.”

While there is ample liquidity from the European Central Bank, that does not mean funding concerns are not an issue, Daiwa Capital Markets credit analyst Michael Symonds said in a research note.

“What is more of a concern is how damaging the steep rise in long-term funding costs will be for the long-run viability of European banks,” he wrote.

After a brief respite earlier this week, Friday’s slide in banking shares pushed the sector index into ‘oversold’ territory again, with its 14-day relative strength index (RSI) falling to 25.4. Thirty and below is considered ‘oversold’.

But other widely-followed momentum indicators such as the moving average convergence-divergence (MACD) and the Stochastics-Slow weren’t signalling any change in trend in the short term.

The six-month slump in the European financial sector has brought stock valuation levels to well below the ones of U.S. and emerging peers.

According to Thomson Reuters Datastream, shares of financial institutions in the Asia-Pacific region trade at 9.7 times forward earnings, U.S. financial stocks trade at 8.7 times earnings, financials in emerging economies trade at 8.5 times and European financials trade at 6.8 times.

Data also show European banks trading at 0.59 times their book value, way below the average price-to-book value of 1.2 for Egyptian banks despite the country’s political turmoil. ($1 = 0.699 Euros) (Additional reporting by Dominic Lau in London; graphics by Scott Barber in London; Editing by Hans-Juergen Peters)

Charlie Munger’s Parody of the great recession

In the country of Boneheadia there was a man, Wantmore, who earned his income as a home mortgage loan originator. Wantmore operated conservatively. All his home loans bore interest rates of 6% or less, and he demanded of all borrowers large down payments, documented proof of adequate income and an immaculate credit-using history. Wantmore sold all his loans to life Insurance companies that, before closing purchases, checked loan quality with rigor—then held all loans to maturity. As Wantmore prospered, he eventually attracted the attention of Tweakmore, a very bold and ingenious investment banker. There was no other investment banker quite like Tweakmore, even in the United States. Tweakmore had become the richest person in Boneheadia, driven by an insight that had come to him when, as a college student, he had visited a collection of hotels that contained gambling casinos located in a desert. As Tweakmore saw immense amounts of cash pouring into cashiers’ cages surrounded by endless sand, in business operations that did not tie up any capital in inventories, receivables, or manufacturing equipment, he realized immediately that he was looking at the best business model in the world, provided one could also eliminate commitment of any capital or expense to hotel rooms, restaurants, or facilities providing parking or entertainment. Tweakmore also saw exactly how he could create for himself an operation that possessed all the characteristics of his ideal business. All he had to do was add to investment banking a lot of activities that were the functional equivalent of casino gambling, with the bank having the traditional “house advantage.” Such casino-type activities, masked by respectable sounding labels, Tweakmore foresaw, could easily grow to dwarfall the action in ordinary casinos. Determined to create and own his ideal business as fast as possible, Tweakmore quit college and entered investment banking.

Within twelve years, Tweakmore was the most important investment banker in Boneheadia Tweakmore rose so rapidly because he was very successful in convincing regulators and legislators to enlarge what was permissible. Indeed, by the time Tweakmore called on Wantmore, any investment bank in Boneheadia could invent and trade in any bets it wished, provided they were called “derivatives” designed to make counter parties feel better about total financial risks in their lives, outcomes that automatically happened. Moreover, an investment bank faced no limit on the amount of financial leverage it employed in trading or investing in derivatives or anything else. Also, Tweakmore had obtained permission to use ”Mark-To-Model” accounting that enabled each bank to report in its derivative book whatever profit it desired to report. As a result, almost every investment bank claimed ever—growing profits and had ownership of assets totaling at least thirty times an ever—swelling reported net worth. And despite a vast expansion of transaction—clearance risk, no big mess had so far occurred.

Tweakmore was pleased, but not satished, by what he had accomplished. And he now planned to revolutionize Boneheadia’s home mortgage loan business in a manner that would make Tweakmore a national hero. In his first proposal to Wantmore, Tweakmore held much of his ingenuity in reserver. All he proposed was that Wantmore hereafter sell all his home loans to Tweakmore at a higher price than life insurers would pay. Tweakmore said that he planned to put all loans into trusts with no other assets, Each trust would be divided into five “tranches” with different priorities in use of loan payments. Four tranches would use their shares of loan payments to pay off complex new fixed interest-bearing, freely-tradable debt instruments, called CDOs . The fifth tranch got a tiny residue in case all home loan payments were received as due. The CDOs would be sold by Tweakmore, using a highly—paid sales force, to anyone who could be induced to buy, even highly—leveraged speculators and small Scandinavian cities in the Arctic. To Wantmore, Tweakmore’s proposal at first appeared unfeasible. The planned operation seemed to resemble the operation of a meat vendor who routinely bought 1000 pounds ofchuck roast, sliced it up, and then sold 950 pounds as filet mignon and the balance as dog food. But Wantmore’s doubts melted away when Tweakmore revealed how much he would pay. Under the offered terms, Wantmore would double his income, something Tweakmore could easily afford because his own income was going to be three times that of Wantmore. After Wantmore accepted Tweakmore’s proposal, everything worked out exactly as Tweakmore had planned, because buyers of CDOs in aggregate paid much more than the life insurers had formerly paid. Even so, Wantmore, as he became familiar with Tweakmore’s prosperity, was soon dissatisfied with a merely doubled income. With Wantmore restive, Tweakmore now displayed the full range of his ingenuity.

What Tweakmore next proposed was that Wantmore add to his product line a new class of “subprime, pay-what-you-wish” home mortgage loans. All loans would bear interest at 7.5% or more, and borrowers would not he allowed to state anything except that they wanted the money. There would be no down payments and no credit checks or the like. Also, each loan would be very user—friendly in its first three years, during which the borrower could make only tiny payments with all unpaid interest being added to principal. After three years, very onerous loan service was required, designed to pay off the greatly swollen principal, plus all interest, over the next five years.

Ths proposal would have seemed preposterous, even hilariously satirical, if it had been presented to Wantmnre when Tweaknwre had first called. But by now Wantmore had doubled his income by going along with a peculiar idea of Tweakmore’s. So Wantmore’s credulity was easily stretched to allow acceptance of the new loan product, which Tweakmore projected would triple Wantmore’s already doubled income.

lt is easy to see why Wantmore became a “true believer” in the new loan product. But why did the already super-rich, prominent, and sophisticated Tweakmore believe his revised scheme would work safely and well for him? Well, we know the answer. As Tweakmore revealed in his prideful autobiography, his thought process was as follows:

•1. There would be no significant troubles during the first three years. Under the accounting standards of Boneheadia, all its accountants would be required for a long time to reserve no loan—loss provision at all against unpaid principal and unpaid interest on the new loans. And CDOs would be valued highly in trading markets because underlying loans were booked at unreasonably high value. It wouldn’t matter that home buyers were making no down payments, had no personal liability at any time, and paid only a tiny portlon of interest accrued for three years. It also wouldn’t matter that any competent inquiry would have revealed extreme past improvidence on the part of most borrowers.

•2. House prices in Boneheadia would not merely rise as they had done before. Prices would rise much faster as more and more people learned they could bid to acquire homes without using any oftheir own money, no matter how poor were their credit-using histories.

•3. All the buyers of new CDOs would have a near perfect investment experience. Ever-rising house prices would cause full payment of all mortgage debt as due. The market for the new CDOs would expand and expand as investors reliably earned much more interest than they could get elsewhere. House prices in Boneheadia would rise faster and faster as the scheme fed on itself in a runaway feedback mode.

•4. True, after the first three years many over-stretched home buyers were sure to suffer somewhat as they were forced, by threats of foreclosure, to sell their homes. This would often cost them their credit and the respect of their children, friends, and employers, but that would be the only trouble, and it would prove endurable by Tweakmore and everyone else, except the people forced out of homes.

•5. The runaway feedback mode that drove up house prices would cause no significant trouble for decades, as had happened in Japan where a big bust in real estate prices occurred only after the Imperial Palace grounds in Tokyo were apparently worth more than the market value ofthe entire state of California.

•6. The principles of economics would give the scheme a large tailwind and considerable popularity. As Tweakmore, a former student in elementary economics, knew from studying Galbraith, a large undisclosed embezzlement strongly stimulates spending because the perpetrator is much richer and the victim spends as before because he does not yet feel poorer. And what Tweakmore was creating was the functional equivalent of a long-running undisclosed embezzlement on steroids. The perpetrators would not be the only ones to spend more, as typically occurs during ordinary embezzlements. The CDO—buying victims also would spend more as they believed they were getting richer and richer from ever-growing paper gains embodied in accrual of interest at above normal rates.

•7. To be sure, the scheme looked a little like a chain-letter scheme, and such schemes were usually ill regarded by prospective users, partly because the schemes were criminal and partly because the schemes always blew up so quickly, bringing criminal troubles so soon. Tweakmore’s scheme, in contrast, would, by design, be lawful and benevolent, and recognized as such, because it would create big macroeconomic stimulus as a public good.

•8. And should the scheme eventually blow up alter decades, like the land-price bubble in lapan, who could fairly blame Tweakrnore? Nothing lasts forever. Besides, the blcwup might be lost in a miasma of other blowups like those sure to come in many irresponsible countries and subdivisions of countries.

Tweakmore’s revised scheme worked fantastically well for a considerable period. Naturally, there were some glitches, but Tweakmore turned each glitch into an opportunity to boost profit. For instance, when Wantmore was made nervous as hordes of scumball salesmen were drawn into his business by rich commissions paid for production of easy-to-sell ”subprime” pay-what-you-wish home loans, Tweakmore responded by buying Wantmore’s business. Then Tweakmore replaced Wantmore with a new CEO, Totalscum, who did not consider any business practice optimal unless it was depraved. Totalscum soon increased loan production by 400%, and his success caused Tweakmore to buy five additional loan businesses and replace their CEOs with people like Totalscum, causing profits to soar and soar, even though Twealtmore never again found anyone else whose depraved operations could produce results that matched those of Totalscum.

As Tweakmore’s scheme went on, it was necessary for its continuing success that the accountants of Boneheadia never stop treating as trustworthy a lot of hugely important loan- payment promises that any sensible person would deem unreliable. However, there was almost no risk that accountants would act otherwise than as Tweakmore desired. The accountants of Boneheadia were not allowed to be sensible, They had to use by rote “rules—based” accounting standards set by a dominating man, Countwrong, who was head of Boneheadia’s Accounting standards Setting Board. And Countwrong had ordained, in effect, that all loss provisions on the new loans must remain based on the zero-loss record that had existed before Wantmore met Tweakmore. And, so long as Countwrong was in charge, no one was going to use in accounting an understanding of runaway feedback modes, instead of Countwrong’s rules.

Of course, if Totalscum or Tweakmore ever started to have loan losses, he would have to start making loan-loss provisions against new loans. But there weren’t any meaningful loan losses for anyone for a very long time. Countwrong was so habit—bound as a thinker that he never recognized that his cognition was anti—social. He had always sought simplicity of process for accountants at the expense of “principles—based” rigor in thought that would better serve his country. He had been rewarded in life for his convictions, and he was now proud of his conclusions, even as they were contributing mightily to the supencatastrophe sure to come eventually from Tweakmore’s scheme. A large economic boom occurred in Boneheadia just as Tweakmore had expected. The boom made the regulators of Boneheadia feel extremely good about themselves as they passively watched the ever—enlarging operations of Tweakmore and Totalscum. A famous regulator named Oblivious was particularly approving. He had been over influenced in early life by classical economics. So influenced, Oblivious loved all the new derivatives, even those based on outcomes of parts of complex CDOs composed of parts of other complex CDOs. And he did not believe the government should rein in any investment banker until the banker’s behavior was very much worse than Tweakmore’s. The boom initiated by Tweakmore lasted only three years. He had underestimated the boom’s strength and the power of people to understand, in due course, super-sized folly. These factors had helped shorten the boom’s duration. Also, Boneheadia had proved less like Japan than had been hoped.

When the hoom—ending bust came, it was a doozy, Almost every investment bank had been made collapse-prone by Tweakmore’s innovations before he became interested in home loans. And now, in a huge bust, most big financial institutions were sure to disappear, causing total chaos and another “Great Depression” unless there was super—massive intervention by the government, financed by printing money. Fortunately, Buneheadia did so intervene, guided by effective leaders who somehow obtained support from politicians in both political parties. And, after this massive intervention, Boneheadia, with doubled unemployment, is enormously worse off than if the boom and bust had never happened. And its options in case offuture trouble are greatly reduced because, after its money-printing spree, it is nearer to facing general distrust of its money and credit. Boneheadia’s bust is now called the “Great Recession”. Yet, even so, not much has been learned by the ellte in Boneheadia. Among the protagonists and too—passive types who contributed so much to the mess, only one has expressed significant contrition. To his great credit, Oblivious has recognized that he was grossly wrong. The accounting profession remains unaware of its large contribution to public woe. And it does not recognize the cognitive defects of Countwrong, which are still believed to be virtuous qualities that reduce accountants’ litigation risks and their duty to cause antagonism by opposing the wishes of some of their best-paying clients.

The professoriate in economics has barely budged toward recognition of the importance of optimized, more conservative accounting in both macroeconomic: and microeconomics. And economics professors, even now, do not recognize what was so easily recognized by Tweakmore: the functional equivalent of undisclosed embezzlement can be magnified and have massive macroeconomic consequences when the victims, as well as the perpetrators, are led to believe they are getting richer under conditions that are going to last for a long time, How about the legislators in Boneheadia? Well, most are confused by what has happened to their most powerful friends and draw no useful implications from the outcome of Canadia, a country just north of Boneheadia that had no “Great Recession” because its simple laws and regulations kept in place home loan operations much like those of Wantmore before he embraced modern finance in the state preferred by Tweakmore.

How about the regulators? Well, very few important regulators or former regulators in all Boneheadia have expressed really serious doubts about the status quo and interest in really serious re-regulation of investment banking. One of the doubters is Follyseer, a long—retired former Minister of Finance. Follyseer has argued that all the contributions of Tweakmore to investment banking should now be removed and banned, because it is now obvious that (1) augmenting casino-type activities in investment banks was never a good idea, and (2) investment banks are less likely to cause vast public damage when they are forbidden to use much financial leverage and are limited to few long-traditional activities. Regarding accounting, no regulator now in power seems to understand, in a way that has any chance of causing effective remedial action, that the disaster triggered by Tweakmore couldn’t have happened if Boneheadia’s system of accounting regulation had been more ”principles—based,” with a different and less tradition-bound group creating accounting standards that were less easy to game.

The former regulator and life-long professor who seemed extra wise aher the Great Recession was England’s John Maynard Keynes, dead for more than half a century. Keynes had predicted, correctly, that “When the capital development of a country ls a by product of the operations of a casino, the job is likely to be ill-done.

Charlie Munger

Afterword: The foregoing parody is not an attempt to describe in a fair way real contributions to the “Great Recession” in the United States. Certain characters and industries, for instance, Tweakmore and investment banking, are grossly overdrawn as contributors to sin and mayhem, while other contributors are not discussed at all. The whole idea was to draw attention to certain issues in accounting, academic economics, and conceivable over-development of finance as a percentage ofthe entire economy, by making the characters and the story line extreme enough to be memorable.

What not to like? Almost nothing as a simple count will produce positive points like,
1) New sexy high growth technology product = high growth, high profitability, premium stock price
2) Unstoppable trend toward outsourcing plus huge market share = Economics of scale = bargaining power with customers = high profitability.

Looking back, it was almost no brainer at that time that as long as I do not pay a high price and I almost got it right except one of the most important point — profitability. It has nothing much to do with downward shift in monitor price. If that is the case, many businesses will be out of businesses within a few years. That included Microsoft.

Technologies change does not resulted to higher profitability even if it has all kind of tail winds. For the past 10 years, TPV is supported by CRT follow by LCD monitor. Profitability of CRT looks better than LCD. Technologies and new products does not provide profitability, demand and supply produce short term exceptional profit and competitive advantage or competitive landscape produce long term profitability. And when technologies keep changing, I am always worried.

What will happen to TPV when LCD TV starts “talking” to all devices? I don’t know, even if TPV is still assembling TV, what will be the cost and selling price like? Facebook is like an exchange, a platform for other to ride on, and can it become something more than that? Very hard and despite being the hottest the website to be, will it continue to hold it 5 years down the road? I won’t bet any money on that. Google like CM said, is something more special, unlike every other website that I know, Google function like an smart toll who main job is to throw traffic out of it rather than hold on traffic as long as possible. If it keep continue, it may become the only toll in the internet world and user like me will be googled and becoming an illiterate literate.

Micro Mechanics keep saying that they are in a tough industry, facing constant price pressure and some of the directors commented that if they knew it earlier, they won’t do it. But this is the best music that I heard. In any industry, the worse thing is to have entrants constantly entering — the most important Force in Porter 5 forces. When the thread of entry is limited in an industry that constantly moving forward requiring smaller and smaller precision component, consumable or not, it will produce an industry that is favourable for incumbent firm.

Sarin Technologies is created by R&D and is easily recognisable that it has competitive advantage. Its competitive advantage is not created by R&D even though R&D is its main focus. It is because Sarin is the big fish in a small pond. A small pond is with few players and a dominant player is a good landscape for better profitability. And it is even better when entry is protected by technologies and reputation. While an entrant with new technologies can harm incumbents, a small industry usually don’t allow entrant to earn enough profit with a new product to establish a comprehensive range of products. What more, new entrant can’t just complete with price alone as reputation is equally important. Currently Sarin is not just building up a range of comprehensive products but by combining products into “stations” to create switching cost.

A Small industry created by technologies selling high price equipments where reputation is equally important, housed a few players of which one is a dominant player. Dominant player is trying to create switching cost. What not to like? Dominant player starts thinking that they are the kings of the industry.

There are not many companies like Sarin Technologies, Micro Mechanics or even TPV. It is not just about having good profitability for a period of time and competitive advantage for Sarin is not unbreakable. Anyway it is still a work-in-progress for Sarin. For many companies, some kind of advantage is created because the industry matured and incumbent firms does not doing anything destructive or has the distribution reach. Some companies generated better profitability in a competitive industry by not joining the crowd.

Talk about OSV industry or even further upstream like contractors and E&P. As one operate further upstream, profit earned will be more and more like an E&P and what determine profitability for E&P is other than lady luck, profitability is ultimately depend on cost and oil price. But the interest here is more on vessel and rig operators and builders.

Think about this, when a company announced that they are contracting to build or to owned vessel cater to a favourable segment of lets say deep water. And let say that segment is the segment to be with favourable demand. What does that mean? Nothing much except that the segment is hot and possibility of higher profit for a short period.

Why? Think about it in this way.

Does that company owned the design? No.
Can any other company owned the same type or even better vessel? Yes.
Is that segment favourable and known by other? Yes and YES.
Is vessel builder earnings good profitability and know about it? Yes and yes
Even if current profitability is going down, is it still better than building other type of vessel serving other industries? Yes.
How hard it is for a bulk ship builder to start building high spec OSV? Very hard. But all it needs to take is just to entry into the segment and every company is moving a step upward.

So where is the competitive advantage? Long term chartering contact? Since it is a contract entered by two parties, benefit is either share by them or one will gain while the other will take the hit. Think about what will happen if the company entered into an unfavourable contract that goes on for 5 to 10 years. Stop. I know someone will say management is smart enough not to do it. Then may I ask, is the other party stupid enough?

Lastly, I said barrier to entry is the most important of the 5 forces. Why? Because as long as they complete base on price alone or partly on price, any big fish will look around for ikan bilis. It does not required ikan bilis to become big enough for pricing pressure. Think about moving up the ladder in term of pricing in the industry. And when barrier of entry is high enough, it created space for incumbents to mature and pull themselves away from new entrant.