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September, 2008: 3 8 14 22 28 30

Disclaimer - IMPORTANT - Read this first!

Investor's Journal is a diary focused strictly on investments and personal finance issues, primarily from a contrarian and retiree point of view. Follow along with an average guy's failures and successes as he learns, by trial and error, the fine art of value investing.

Since the last entry, our Leapin' Lizards (LL) pick, RCMT, purchased on 8/27/07, has also been held over a year. It too will be sold at the early market price Thursday morning. It will then be removed from the LL open positions portfolio, and its closed position info recorded, based on the 8/27/07 to early 9/4/08 per share performance. Through the close of trading on 9/3/08, after subtracting a commission (while not counting any dividends), RCMT had been down 63.27% in the past 12(+) months.

Since the last entry, our Classic Value (CV) pick, AFG, purchased on 8/29/07, has been held over a year as well. It will be sold at the early market price Thursday morning. It will then be removed from the CV open positions portfolio, and its closed position info recorded, based on the 8/29/07 to early 9/4/08 per share performance. Through the close of trading on 9/3/08, after subtracting a commission (while not counting any dividends), AFG had been up 3.13% in the past 12(+) months.

My top-ten equities for mention today are: ACE; ENH; FLXS; HCC; MIG; MRH; MTW; MXGL; NTRI; and TRV.

The focus this time is on an asset mentioned in the last entry but not yet officially added to the portfolio. I am rectifying that at this time as it still looks like an excellent new Classic Value (CV) selection: Manitowac Company, Inc. (MTW) (recent price $23.65). MTW's trailing price to earnings ratio is just 7.46. Its forward P/E is estimated at 6.16. The asset's market-capitalization size is mid-cap: $3.03 billion. Manitowac Company, Inc. has a 0.30% dividend, with a dividend payout ratio of 0.03. The price to sales ratio is 0.71. The PEG ratio is 0.23. MTW's price to book value is 1.95. There is positive free cash flow. Return on equity is 31.45%. Debt to equity is 0.15. The current ratio is 1.54. This stock has low price to earnings and low debt in its favor. It meets Ben Graham's value and safety bargain stock criteria.

Manitowac Company, Inc. will be added to our CV tracking portfolio, as well as our own nest egg, at its market price early on Thursday, 9/4/08.

Incidentally, as I have mentioned before, there is now a discrepancy between our official hypothetical portfolio sell indicators and what my wife, Fran, and I are actually doing in our own nest egg. Generally, we are holding CV assets that are down or only up a little, and for which I think there is more price potential, based on the current price to value (P/V) calculations still being low. I do think, for instance, that both VSH and AFG may be headed higher in time. So we are inclined to be patient and give them up to another year or so.

As yet, we do not have a final sell strategy worked out, but ideally we would like to see at least a 50% increase in an asset's price over the cost basis or to have held the asset about 2-3 years, whichever first. This approach, though, is most appropriate when there is a shortage of funds for new investments. When that is not the case, one might simply hold each CV asset indefinitely, so long as its P/V remains low.

As a rather rough (not hard and fast) rule, before selling I would like, depending on the purchase criteria, to have held the stock for at least a year and a day and see the current P/Bk 1.2 or higher, or the P/E 15 or higher, and/or the dividend no greater than 1/2 the current average AAA corporate bond yield.

For instance, if I had bought the asset mainly based on a P/Bk of 0.6 and it now has a P/Bk of 1.3, I might go ahead and sell it even if its P/E were now below 15, so long as the trailing price to earnings ratio were not presently itself low enough to meet Ben Graham buy standards.

Another way of looking at the sell strategy is to assess how profitable the overall CV portfolio closed positions have been. If the average closed position annualized performance has been in the 15-20% range, one might be more comfortable raising cash by selling currently open positions that have simply been held a year and a day, so long as doing so does not reduce the overall return below the 15% threshold.

Now, however, in our CV hypothetical portfolio closed positions we see an average annualized performance of only about 12%. While this compares favorably with the overall market performance in the same period, based on research by Ben Graham and his firm it is significantly below what we should expect for CV as a long-term strategy. So under current conditions it seems more appropriate to be conservative in one's selling strategy, knowing that, over time it is likely CV techniques have the potential to offer gains of at least 15% (after frictional costs, such as commissions, but before dividends).

Hopefully, these comments are clearer than mud and seem to make sense. If not, I invite the reader to follow up with comments or questions that may further develop or refine the case for or against particular CV selling plans. We might all benefit from such a discussion.

9/8/08-Since the last entry, our Leapin' Lizards (LL) pick, MALL, purchased on 9/4/07, has been held over a year. It will be sold at the early market price Monday morning. It will then be removed from the LL open positions portfolio, and its closed position info recorded, based on the 9/4/07 to early 9/8/08 per share performance. Through the close of trading on 9/5/08, after subtracting a commission (while not counting any dividends), MALL had been down 29.07% in the past 12(+) months.

My top-ten equities for mention today are: ACE; AMPH; AXS; CALM; HCC; LOV; MIG; RMCF; AMPH; and WRB.

The focus this time is on a new Classic Value (CV) selection, American Physicians Service Group, Inc. (AMPH) (recent price $20.50). AMPH's trailing price to earnings ratio is just 7.22. Its forward estimate of P/E is 9.32. The asset's market-capitalization size is nano-cap: $146.27 million. American Physicians Service Group, Inc. has a 1.50% dividend, with a dividend payout ratio of 0.11. The price to sales ratio is 1.75. AMPH's price to book value is below average at 1.14. There is positive free cash flow. Return on equity is 16.87%. Debt to equity is 0.00. The current ratio is 9.58. This stock has low price to earnings, low debt, and a relatively low P/Bk in its favor. American Physicians Service Group, Inc.'s shares currently meet Ben Graham value plus safety bargain stock criteria.

AMPH will be added to our CV tracking portfolio, as well as our own nest egg, at its market price early on Monday, 9/8/08.

As the volatile, generally down market has taken its toll, I have nervously watched as our net asset value has fallen farther and farther. We lost over $30,000 (in paper value) in August alone. This weekend I updated our records, though, and found the overall assets have not gone down as much as I had thought, "just" 9.1% so far in 2008 (knock on wood!). That it has not been more has been due, I suppose, to our being well allocated.

And the total equities' book value has continued to hold up well, now standing at $604,000, so that our equities' market value (or overall price) to book value is still 0.9. Subtracting the stock mutual funds, our individual equities' book value is $564,000, up at a compound rate of just under 28% a year since it stood at $108,500 at the end of 2001.

Heartening as those figures are, I am a bit impatient to again see equity market prices once more heading upward! Perhaps they will once the U.S. presidential election is over. On the other hand, it is not unlikely that any spike in stock prices may be followed next year by a severe drop, perhaps testing or exceeding the lows seen in the 2000-2002 period. We shall see. The trouble, as I see it, is that our economy in several respects now appears to have an unstable foundation. Nonetheless, I do not believe in running for cover. While I am never "fully invested," I want to always have a significant equity exposure.

Meanwhile, I am continuing my thinking about sell criteria. Am experimenting, when I need the extra cash to purchase new securities, with reviewing stocks for possible sale that now have a high price to value. The easiest way I have found to identify a few sell candidates, regardless of how long they have been held, is to multiply the P/E by the P/Bk. At this time, I am looking only at assets with a P/E x P/Bk product of 30 or higher. Of course, if either the book value or the earnings are now listed as just "NA" (and if that is consistent at more than one site that provides such stock information), I calculate that as zero, the price to value product thereby becoming infinite. I retain all such possible sell assets, however, so long as they have: 1. at least one Ben Graham value criterion met, i.e. high enough dividend (with payout ratio 0.5 or below), low enough P/E, or low enough P/Bk (0.8 or less), AND so long as they still have a debt to equity ratio of 0.33 or less.

Based on this analysis, in our own nest egg we are today selling LNDC (bought late last January) at a small loss.

9/14/08-Since the last entry, our Classic Value (CV) pick, PMI, purchased on 9/11/07, has been held over a year. It will be sold at the early market price Monday morning. It will then be removed from the CV open positions portfolio, and its closed position info recorded, based on the 9/11/07 to early 9/15/08 per share performance. Through the close of trading on 9/12/08, after subtracting a commission (while not counting any dividends), PMI had been down 89.68% in the past 12(+) months, evidently decimated by the crash of the housing bubble and overexposure to sub-prime mortgages.

My top-ten equities for mention today are: ACE; AXS; FLXS; HCC; IPCR; MIG; MRH; MTW; NTRI; and TRV.

The focus this time is on a new Classic Value (CV) selection, Flexsteel Industries, Inc. (FLXS) (recent price $11.08). FLXS's trailing price to earnings ratio is just 7.52. The asset's market-capitalization size is nano-cap: $72.85 million. Flexsteel Industries, Inc. has a 4.69% dividend, with a dividend payout ratio of 0.35. The price to sales ratio is 0.17. FLXS's price to book value is well below average, at 0.63. There is positive free cash flow. Return on equity is 8.70%. Debt to equity is 0.20. The current ratio is 4.23. The shareholder equity to total assets ratio is 0.66. This stock has low price to earnings, low debt, low P/Bk, and a healthy dividend in its favor. Flexsteel Industries' shares currently meet Ben Graham value plus safety bargain stock criteria.

FLXS will be added to our CV tracking portfolio, as well as our own nest egg, at its market price early on Monday, 9/15/08.

Based on reader response, I unintentionally misled with the following comment in the last entry, "...our individual equities' book value is $564,000, up at a compound rate of just under 28% a year, since it stood at $108,500 at the end of 2001." What I had been assuming but neglected to clarify was that a major reason for the climb in our individual asset equities was a shift out of mutual funds and into individual common stocks. Rather than that 28% rate of increase coming from brilliant investing, the buildup of equity book value corresponded to: 1. the greater proportion of our total assets that were then in individual securities; 2. a focus on low price to book value stocks with the extra funds from redeemed mutual funds; and 3. the growth of the portfolio over time. The actual increase in book value just due to (hopefully) intelligent investing is hard to separate out but probably has been closer to 12-15% a year since my retirement in December, 2001.

9/22/08-Since the last entry, our Leapin' Lizards (LL) pick, ALLI, purchased on 9/17/07, has been held over a year. It will be sold at the early market price Tuesday morning. It will then be removed from the LL open positions portfolio, and its closed position info recorded, based on the 9/17/07 to early 9/23/08 per share performance. Through the close of trading on 9/22/08, after subtracting a commission (while not counting any dividends), ALLI had been down 22.42% in the past 12(+) months.

My top-ten equities for mention today are: AMPH; ANF; AXS; MEI; MIG; MRH; MTW; MXGL; TRV; and VR.

The focus this time is on a new Classic Value (CV) selection, Montpelier Re Holdings, Ltd. (MRH) (recent price $17.32). MRH's trailing price to earnings ratio is just 6.65. Its forward estimate of P/E is 6.90. The asset's market-capitalization size is small-cap: $1.58 billion. Montpelier Re Holdings, Ltd. has a 1.70% dividend, with a dividend payout ratio of 0.13. The price to sales ratio is 2.60. MRH's price to book value is below average at 1.03. There is positive free cash flow. Return on equity is 15.18%. Debt to equity is 0.22. The current ratio is 7.02. This stock has low price to earnings, low debt, and a relatively low P/Bk in its favor. Montpelier Re Holdings, Ltd.'s shares currently meet Ben Graham value plus safety bargain stock criteria.

MRH will be added to our CV tracking portfolio, as well as our own nest egg, at its market price early on Tuesday, 9/23/08.

Like so many others, I have watched the unfolding of our nation's (soon to be the world's, I believe) current financial crisis with both dismay (that all the federal spending to keep the markets liquid will prevent future presidential administrations from doing the many other things still needed, such as fixing health care, developing and launching a sensible energy policy, assuring adequate military spending, upgrading education, beginning vitally required infrastructure upgrades, heading off looming deficits in Medicare and Social Security, etc.) and anxiety (that things might at any moment get so out of hand that not even our heroic Treasury Secretary Henry M. Paulson, Jr., will be able to put the U.S. financial sector, or indeed the global economy, together again, and we shall see a total systemic failure that would wipe out not just Fran's and my nest egg, but much of the rest of the country's wealth). I have wondered if I should sell everything and put the net proceeds into money market accounts. I noticed that for awhile even one of the latter was in jeopardy, returning 97 cents for each dollar invested.

In the end, I decided, at least for now, to trust that enough rabbits will be pulled out of Secretary Paulson's hat that the entire system does not quite implode and we may get through this by the skin of our teeth (to thoroughly mix metaphors!). Accordingly, I have avoided making many redemptions.

Nonetheless, I did freak out to the extent that I sold enough currently profitable assets (so I would not be locking in the losses) to pay off our already modest level of margin debt and raise some extra reserves, so I shall hopefully be able to buy up still further depressed (bargain level) stocks in the months or years ahead. I also have reallocated to some extent, to ideally leave us with a less volatile overall portfolio.

We are left with a nest egg of liquid assets (besides our non-liquid real estate holdings and related personal or collectible assets) now worth about $650,000 (down from roughly $725,000 at the beginning of the year). This liquid portfolio is broken down roughly as follows:

• The biggest division is between equities, now $433,000, give or take a thousand or so, and a mixture of bond assets and money market or equivalent cash-like reserves, now $217,000, also give or take a thousand or two (including inflation-protected bond mutual funds, exchange traded fund [ETF] bond assets or energy trusts, money market accounts, etc., the overall yield of this non-equities grouping now standing at about 7%).

• Several asset categories make up the $433,000 equity portfolio.

• Classic value assets are the largest portion, though now significantly lower than just awhile ago, at roughly $162,000.

• Next is Berkshire Hathaway's Class B shares (BRK/B), now worth $136,000.

• Then comes a long-term "core equity" category, everything from mutual funds bought years ago, the largest amount being in Fidelity Low Priced Stock Fund, to stock spin-offs that just never got sold, about 10 assets bought earlier using "Wild Wizard" criteria, a smattering of stocks recommended by strategists I follow on The Motley Fools' site, etc. This segment of the pie is now worth about $105,000.

• About $30,000 is invested in precious metals ETFs.

I expect that the main change in the months ahead will be the gradual build-up again of classic value through new asset purchases, such as the one, MRH, cited today.

My intention with respect to the equity vs. non-equity holdings is to keep these categories in roughly 67% and 33% proportions of the total liquid assets pie, respectively, but not to usually rebalance until the equity portion is at least 3-4% higher or lower. Thus stocks and stock mutual funds will be allowed to vary between around 63% and 71% of the total liquid nest egg. If they get to be too large a part of the portfolio, they will be sold off, typically at a profit. When they get too low, more will be bought, usually at bargain levels.

I anticipate that, as the financial crisis plays itself out over the next several months or years, the markets will at times surge strongly and at others drop precipitously. These fluctuations will then be occasions for such rebalancing to occur, resulting hopefully in a little gain each cycle between the assets being purchased at the lows and sold at the highs. The technique is hardly original. A similar strategy was suggested in Ben Graham's popular book, The Intelligent Investor.

To prevent equities from becoming too large a proportion, simply because I am periodically buying them on a dollar-cost-average basis (with these focus stocks, purchased about every week or two when I am in town), I shall (each time new equity buys are made but there is not a rebalancing due) invest about half the new equity buy amount in non-equities.

Naturally, as things are so unstable in the financial world lately, I am not certain this will be the last time I make adjustments in our investing approach. But I expect this strategy is likely to be continued for the next year or so. We shall see!

9/28/08-Since the last entry, there have been no assets held for at least a year, so sales are not now in order among the Classic Value (CV) or Leapin' Lizards (LL) portfolios.

My top-ten equities for mention today are: ANF; COP; ENH; FSR; HCC; MEI; MTW; RLI; RNR; and TRV.

The focus this time is on a new Classic Value (CV) selection, Conoco Phillips (COP) (recent price $76.24). COP's trailing price to earnings ratio is just 6.92. The forward P/E is estimated at 6.00. The PEG ratio is 0.54. The asset's market-capitalization size is giant-cap: $115.87 billion. Conoco Phillips has a 2.40% dividend, with a dividend payout ratio of 0.16. The price to sales ratio is 0.56. COP's price to book value is 1.26. There is positive free cash flow, with a price to cash flow of only 4.4. Return on equity is 19.88%. Debt to equity is 0.24. The current ratio is 0.96. This stock has a low P/E, below average P/Bk, low P/CF, and low debt in its favor. It meets Benjamin Graham's bargain stock safety and value criteria.

Conoco Phillips will be added to our CV tracking portfolio, as well as our own nest egg, at its market price early on Monday, 9/29/08.

Due to recently more frequent analyses, we are getting a few more than the originally intended portfolio of 25 CV assets. But I am aware that in the next few months I shall several times be out of town, unable to easily do entries till my return, so that during that period more assets will be coming due for sale than are being added.

Besides, as the market is down, it seems opportune to point out some of the abundant bargains. Normally, I might have a hard time finding several low priced (relative to their value) stocks for focus if the next analysis came sooner than a couple weeks later. Currently, there is no such difficulty. It is common these days to find a number of assets selling at 80% or (even much) less of their value.

I am under no illusion that the stocks mentioned here will not go down significantly further as/if the bear market persists. But timing is not my game. And it seems logical that many of these securities will retain their higher value (than current market prices) and so eventually, when a friendlier market environment in time develops, deliver substantial profits to those who buy now (or even buy again, once the prices might offer still better bargains).

We are winding down the month of September. It has certainly been an interesting 3rd quarter. In the next entry I shall be giving my usual quarterly summary of the hypothetical portfolios to date. It promises to not be one of our proudest reviews, but any embarrassment will likely be tempered by a comparison of Classic Value's performance with that of the major market averages!

9/30/08-Here, through the third quarter of 2008, is the latest performance summary for the tracked portfolios:

(The statistics combine portfolio open and closed position results and are effective as of the end of trading 9/30/08. Dividend income has not been included in the portfolios' performance. Commissions, though, have been subtracted from the portfolio asset results, but not from the SPX gains.)

( *since our CV & SPX records' inception, 10/4/04, and our LL records' inception, 10/8/04)
(**SPX is used as a proxy for the S&P 500 Index.)

Latest observations about the portfolio results:

• We are clearly in a bear market. In addition, there is great market instability. In only the last two trading days, the S&P 500 Index has been down about 8%, then up around 5%. There have been quite a number of large daily gyrations over the past several weeks. The decline has hit small-cap securities particularly hard, especially those in the financial sector. For instance, our Classic Value (CV) pick, HIG, lost over 18% today alone despite a strongly rising market. Given the drubbing our selections have taken in the last many months, the remarkable thing is that on average our CV picks are still in positive territory, if only in single digits.

• Once conservative dividend rate estimates, of about .5% for the open plus closed position Leapin' Lizards (LL) assets and about 1.7% for the open plus closed position CV stocks, have been added, the annualized LL total return to date would still show a 1.86% loss since inception, while the CV picks would have performed at a positive total return rate of just under 7% (6.95%) a year. The total return difference in the two hypothetical portfolios would be nearly 9% in favor of the CV approach.

• As often suggested before, the longer term records of the closed positions seem to me to more accurately reflect the potential and pitfalls of the respective portfolios than do the short-term swings of the open position assets. If we look only at the closed positions, then, we see that, as usual, both the LLs and the CV assets have held up a little better. The LL closed position performance has averaged a gain of 0.19% compounded annually, for a total return of about 0.69% a year, once a conservative LL dividend of 0.5% has been included. The CV closed position performance has averaged 11.26% compounded annually, for a total return of about 13% (12.96%) a year, once a conservative CV dividend estimate of 1.7% has been included. By this method of comparing the two hypothetical long-term portfolios, CV tops LL by over 12% annually, just as was the case at the last quarterly review.

• To reiterate, although for purposes of the hypothetical portfolios the analysis will still be based on sales after a year-and-a-day, I no longer am advising folks to automatically sell long-term hypothetical portfolio type assets after a particular hold period. Rather, it seems best to assess potential security sales on a case by case basis. If at the year plus a day analysis they still represent good price to value, I personally would hold them till that is no longer the case or they have been in my portfolio a couple years, whichever occurs first. (Unless essential for overall portfolio management, it still seems foolish to sell at a loss into a bear market, particularly when there remains good value in a stock.) If this approach is followed, it seems probable returns will be improved over those from using a mechanical year-and-a-day sell rule, and then the prospects of long-term average annualized total returns in the 15-20% range may be feasible, even after such shocks to our financial system as are being experienced currently.

• For a hypothetical 50/50 CV/LL Blend, the closed position figures would indicate an annualized total return record of about 7%.

• However, the 50/50 CV/LL Blend's overall (open plus closed positions) annualized total return is estimated, given the figures through 9/08, at only about 2.55%, a bit better than the total return for a 10/4/04 buy and hold investment in the S&P 500 Index (with dividends).

• The 50/50 CV/LL Blend's combined closed positions since inception now number 152. Of these, 69 have turned out to be losing stocks in the periods they were held, while there were 83 winners. The Blend's win to loss ratio has thus fallen to 1.20.

• Through 9/08 and for CV stock picks, 34, or 40.48%, of the 84 closed position assets turned out to be losers, a win to loss ratio of 1.47.

• Among the 68 LL closed position assets, 35, or 51.47%, were losers. Their win to loss ratio was just 0.94. Taking all the results to date into account, it does not seem wise to focus on LL stocks, which emphasize low price to sales, low debt, and good momentum. For the period under review, they have actually performed worse even than a virtually flat overall market.

• Since we did not buy and sell SPX shares in equal amounts each time we did so for the CV and LL portfolios, it is not possible here to directly compare the record of the hypothetical portfolio "apples" vs. market average "oranges." Intuitively, though, it appears that a long-term focus on Classic Value assets has the potential for a several percentage points advantage over the S&P 500 Index (which itself, research shows, is superior to the record of 80% of managed stock funds).

• At least in our own portfolio, this has been to be the case. Even after net retirement expenses over income and now two major downturns in the market, our assets are up over 40% since we retired (me in 12/01, Fran in 5/02). While over the past year the S&P 500 Index has lost 23.71%, our nest egg has fallen roughly half as much, down 11.81%. Significantly, we have emphasized low price to value assets such as Fidelity Low Priced Stock Fund, Berkshire Hathaway shares, and a wide assortment of Classic Value selections.

• As usual, because there is always the possibility of either foreseen (such as a likely continued credit crunch, a major housing slump, a deepening recession, dollar weakness, high oil prices again in the future, and further market turbulence) or unforeseen developments (which might include virtually anything, from a new terrorist attack, out-of-control inflation, war with Iran, further deterioration in the global economy, instability in China, Russia, Pakistan, Saudi Arabia, or all of the above, etc.) spooking the stock market more and causing large losses to one's nest egg, I urge investors to keep debts low and maintain a reserve of cash equivalent assets. As noted last quarter, this may be a good time to reallocate and gradually increase one's equity percentages relative to non-equities, as stocks are definitely still in a slump and there are nice bargains out there.

• Meanwhile, as was the case last quarter, it is also true that we find it frustrating that a relatively long period is passing while the market and our assets are down, with little prospect of their heading north soon. Perhaps from the outset an investor is better served by having, as Warren Buffett has recommended, "low expectations."

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