Investing Ideas

The more i think about Microsoft’s new business model the more I like it.

• Customers win because they buy items cheaper. A 2-3% saving is as good as what you get from a cashback rewards card.
• Advertisers win because they are guaranteed to make money. No more click fraud. No more paying for clicks without converting to sales.
• Microsoft wins because they could increase search market share. Im not sure how successful this will be but it will have at least some impact on Microsoft’s share of the search market.

 Disclosure: I own shares of Microsoft

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An excellent article by Bill Gross about how the FED is underreporting inflation. If you are a regular reader here you probably read this in my Article “Here’s a TIP buy TIPS” Bill Gross has an interesting chart in his article showing CPI composite for 24 countries. The article is a must read.
My simplified version of Bill Gross’ article is

Housing
The housing component of CPI is based on how much the house would rent for. The large increases in the cost of buying a home these last few years are not in the CPI since home prices went up but rent has not risen as much. Who cares that the majority of people own homes or want to buy homes, lets look at rent to reduce inflation numbers.

Geometric weighing and Substitution
Using geometric weighing, Goods and Services which increase in price are given lower weight because people would consume less of those goods and services.  So if milk and bread increases in price the government assumes we will eat less milk and bread. Substitution outright replaces what you consume, it says if people cant afford Steak they will buy burgers so lets look at burger prices instead. CPI is supposed to calculate how much the costs increase to live the same quality of life. The current CPI calculates inflation for a deteriorating stand of living.

Core Inflation
So how do you top the brilliant ways to reduce inflation pointed out above? Use Core CPI. The fed and government use core CPI which ignores Food and Energy.  Like i’ve said before I would like to see these people who do not eat, do not drink, do not drive or use electricity. The lower a persons income the higher the effect from Food and Energy. Someone on minimum wage or lower will spend 30-40% of his money on Food and Energy which the really wealthy might just spend 5%-10%.

I propose a solution, before becoming a fed governor the person has to live on minimum wage for 1 year. That should sort this out.

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Microsoft today released a brilliant new business model for search. After reading the views and comments of a lot of opinions I find that the business model is misunderstood by many. Here is a link to one such misunderstood article by Henry Blodget

His first reason why this wont work is

“1 million $1 clicks generate $1 million of revenue for Google, but even if Microsoft gives 50% cash back on each click, that’s only 50 cents per user per transaction. If you’re buying a $5 item, 50 cents is a nice refund, but if you’re buying, say, a $25 item, it’s chump change. “

What Microsoft is proposing is competely different. Microsoft is saying to advertisers, dont pay us for clicks, pay us when you SELL something. Microsoft will then share their revenue with the buyer similar to Cashback programs from Credit Card companies. This cashback amount isnt a percentage of click, its a percentage of the price of the item sold. If microsoft offers cashback of 3 to 5% on most of their items they could save consumers hundereds of dollars a year by switching from other search engines to Microsoft. Here is an example of Circuit city is offering 13% cashback or $11.70 on a $90 camera Samsung S860 Digital Camer. You can see an excerpt from the Microsoft press release.

Participating merchants choose to pay Microsoft a CPA fee each time a customer completes a sale through Live Search cashback. The fee is a percentage of the retail price, and when that transaction is complete, Microsoft returns that fee to the consumer in the form of a cash rebate.

Take a look at Microsoft list of stores shows hundereds of stores offering cashback offers on thousands of products and we can simply ignore the second reason which was “The program only covers “participating” retailers and “participating” products, at least initially. Finally whether or not Google or Yahoo fight back with a similar plan is pure speculation. Lets see how they respond. If they do follow Microsoft’s lead and offer cash back it will cut into profits and it will take them some time to come up with the platform to offer this service.

This is a leap (not just a step) in the right direction for Microsoft in the search business.

Full Disclosure : I own shares of Microsoft.

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Markel (MKL) in the business of specialty insurance business. They usually have very little to no competition and can charge high rates because they provide insurance solutions to niche markets. Markel has a history of making an underwriting profit (ie. They take in more money in premiums than they pay out in claims) and is extremely disciplined about underwriting insurance. Markel’s invesment portfolio is run by Tom Gaynor who is a great value investor and has had market beating performance for years. In my opinion Markel is already at a fair value and it might get cheaper. Warren Buffett has mentioned that insurance rates are falling, in the short term this has put downward pressure on all Insurers. Share of Insurance companies also usually drop going into Hurricane season. There may be a chance to buy this great company at a wonderful price.

Valuation
In this October 2000 Businessweek article Bruce Berkowitz of Fairholme mentioned how he valued Markel.

“Look, the key concept for insurance companies is to take a look at the investments per share. And you can find companies where the investments per share are significantly higher than the stock price. Markel has roughly $400 per share of investments. If they can break even on their underwriting and only make a 5% after-tax investment return, that’s $20 per share. Not bad for a company at $140 per share. So the trick is to have that investment leverage and at the same time break even or make an underwriting profit.”

Any underwriting profit that Markel makes is a bonus.

What are the current numbers ?
Markel has $7,122,257,000 in Investments and $612,056,000 in cash. With 9,947,000 shares outstanding that works out to $777.55 per share in Cash and Investments

Per share cash and investments: $775
5% after-tax investment returns: $38.87
Current share price: $406

Berkowitz bought Markel at 7 times what the investment returns would be. To buy Markel now at the same valuation of 7 times that Berkowitz paid in 2000. You would need to buy the shares at $272. Markel’s visibility has increased a great deal in the last few years with a lot of people comparing it to Berkshire Hathaway. See my article of the next Berkshire Hathaway’s which included Markel. A chance to buy Markel at a valuation of 7 looks extremely unlikely but I feel that any valuation under $390 which is 10x estimated after-tax investment return seems a decent price for Markel. The shares have dropped from last years peak of $554 down to $406, I have my fingers crossed for.

Disclosure : I do not own shares of Markel. I do plan to buy at these levels and I hope to buy a lot more if the shares go lower.

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One of the best places to get some great investing ideas is the 3rd Annual Value Investing Congress West which was held on May 6th and 7this in progress as i write this. The Value Investing Congress is a collection of some of the best and brightest value investors in the country. Most of the the speakers at this congress follow the Graham/Fisher/Buffett form of investing and will be sharing their best investment ideas.
This year the Speakers and their investment ideas were

I cannot guarantee the accuracy of the list above since im collecting the information from other articles and blog posts.

Disclosure : I own shares of Berkshire Hathaway. I do not have positions in any of the other companies mentioned above.

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