William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

As value investors and proponents of low turnover portfolios, we at Smead Capital Management are concerned about becoming New Age Visionaries. Fortunately, we are in tune with investing great Warren Buffett, who came out with his annual letter over the weekend. As veteran Buffett watchers, we can see that he is out “New Aging” the “New Agers” and identifying Oil as the “New Salt”.

Once upon a time, people packed their meats in salt to preserve them. For this reason, salt was a very precious commodity. My cousins (Schmied’s and Krutz’s) moved to Hutchinson, Kansas in about 1875, because Jay Gould bought a salt plant there and one of my cousins had a management position with Gould’s company. Gould was the Carl Icahn/Ron Burkle of his day and ironically, his core business was the railroad business. He owned peripheral businesses which could somehow contribute to rail line activity. However, instead of putting a high price on salt at the time (which folks did), they should have been preparing for the emergence of ice boxes and refrigeration. When those “New Age” technologies came along, salt lost a great deal of importance and prices reflected the loss of demand.

In the early 1900’s, horses and oats were highly valued commodities because humans and goods were transported in those days by horse drawn wagons. In a wonderful paper called, “From Horse Power to Horsepower”, author Eric Morris shared how horses and oats became the “New Salt”. In the year 1900, four thousand automobiles were sold in the US. Instead of putting high prices on oats and horses, folks should have been prepared for their prices to drop as auto sales in the US hit 3.5 million in 1925. To be a New Age thinker back then you had to be thinking of gas stations, convenience stores and motels for newly mobile Americans.

This brings us to Buffett’s Annual Letter. Berkshire Hathaway is taking a large and capital intensive position in the Electric/Natural Gas Utility Industry via Mid-American Energy and the US Railroad Industry via its purchase of the Burlington Northern/Santa Fe Railroad. Berkshire also owns a company, BYD, which makes electric auto engines in China. And Berkshire is selling shares of oil company, Conoco Phillips, to buy the railroad. Buffett obviously thinks that Oil is the “New Salt”. He has already stated publicly that we will all be driving electric cars in twenty years. Railroads transport coal and much of our electricity is made out of coal. Therefore, his company is now one of the largest companies providing fuel and engines to electric cars.

Buffett reminded everyone in his letter that you should be concerned about the profitability of your companies over the next ten to twenty years, not the next 10 to 20 weeks. Short holding periods for industries with bright near-term futures are very popular just like they were in 1999 for tech stocks. Poor longer-term fundamentals could put investors into a Cinderella position, where you run out of time and everything turns into pumpkins and mice. Wayne Gretzky was once asked why he was such a great hockey player and he answered, “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.” At SCM, we believe that Oil is the “New Salt” for this very reason.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

For a long-term multi-year bull market to exist in stocks in the US, a number of things need to fall into place. Since we at Smead Capital Management enjoy owning high quality large cap US equities for long holding periods and seek to find “Hall of Fame Companies”, we would like to see a long bull run play out over the next 3-5 years. We thought it would be helpful to line up the current “ducks” to see if the markets have done what they need to do for this bull market to last for a long time.

Duck No. 1—Negative Sentiment

When this market sneezes, investors get a cold. A recent 7.5% pullback in the S&P 500 Index caused individual investor sentiment and professional investor sentiment to plunge. Mark Hulbert covered this in a column called “A mid-winter night’s gloom” in which he showed that short-term professional market timer’s had reduced their equity exposure in a short time by 45%. Both the Investor’s Intelligence and American Association of Individual Investor’s (AAII) surveys saw the number of bulls plummet and the number of bears or people looking for a correction soar.

Duck No. 2—Insider’s Positive

The recent pullback in the market saw a big drop off in insider selling (Officers and Directors and Substantial Stockholders of public companies). When the Insider’s are big sellers of dips, beware.

Duck No. 3—Favorable Supply and Demand for Shares

Every week another major acquisition announcement is made. Most are all cash (Terra Industries $4.1 billion) or mostly cash purchases (Berkshire Hathaway’s buy of Burlington Northern). When shares of stock are bought out for cash, the supply of shares outstanding decline. Major stock buyback announcements have been fairly constant (Merck and Amgen in our stable are recent examples) and are being executed, wiping out more supply. In more normal times this supply elimination would be offset by Initial Public Offerings (IPO’s) and Secondary Common Stock offerings. Ask any investment banker, IPO issuance is almost non-existent.

Duck No. 4—Massive Cash on the Sidelines

US households ($7 Trillion), Banks ($1.2 Trillion) And Non-Financial Corporations ($1.8 Trillion ) are holding record levels of cash on their balance sheets. When confidence comes back a significant piece of this amount will either participate in business growth or stock purchases.

Duck No. 5—Negative “Nabobs” have Credibility

Any two-bit economist or market strategist who foresaw the sub-prime meltdown is treated like a god/guru and like they have a crystal ball. They all say the same thing about the US economy in one way or another. The US has seen its best days and we are in for a long deleveraging phase. In their mind commodities and emerging markets are a better place to invest than the best companies in the world domiciled in the USA.

Duck No. 6—The Public Can’t See the Ducks

We believe US household investors and many institutional investors are looking in the rearview mirror at the horrid decline of October 2007-March 2009 and can’t see the ducks lined up. Remember, US households were net liquidators of US common stock last year.

We are very excited to own the companies which fit our eight criteria and look to enjoy the ride as we believe investors will slowly recognize that the “ducks are lined up”.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

Last week those of us at Smead Capital Management got to listen to the wisdom of Warren Buffett and Hank Paulson. We also read some terrific economic history from Joel Kotkin in a column called “America on the Rise”. I’d like to share some of their thoughts and connect them. In this way we can help folks understand why we think this is one of the best times to own US high quality common stocks by looking for Hall of Fame Companies and use long-term holding periods.

Mr. Buffett interviewed Hank Paulson in Omaha at a big Chamber of Commerce gathering. They spent most of their time talking about the tough decisions which Paulson spearheaded in the fall of 2008 as US Treasury Secretary in the Bush administration to avert an economic catastrophe. In the second half of the talk, Hank shared some thoughts which really solidified our feelings about the “group think” which has a tendency to dominate investment decisions in the short run. He said, “Every other economy, including China, has more significant problems than we do.” You might need to read what he said again. Paulson was Treasury Secretary from June of 2006 to January of 2009 and had been the leader of Goldman Sachs in the years just prior. We have just spent the last two years hearing from a wide variety of economic pundits. Almost all of them have told us that the cleansing of 2007 through 2009 and the overhanging debt of the past 15 years is ushering in the decline of American economic glory. Whether it is “seven lean years” or the “new normal”, we’ve heard it and seen most of the people who manage money adopt it as the foundation of what drives their investments and asset allocation.

Kotkin piggybacks Paulson by demystifying China’s future and rebuts George Will’s recent writing about American “declinism”. He does this by sharing some economic history and by sharing key attributes of long-term economic growth.

“Rarely mentioned in such analyses is China’s own aging problem. The population of the People’s Republic will be considerably older than the U.S. by 2050. It also has far more boys than girls–a rather insidious problem. Among the younger generation there are already an estimated 24 million more men of marrying age than women. This is not going to end well–except perhaps for investors in prostitution and pornography.”

“In the longer term demographic trends actually place the U.S. in a relatively strong position. By the end of the first half of the 21st century, the American population aged 15 to 64–essentially your economically active cohort–are projected to grow by 42%; China’s will shrink by 10%. Comparisons with other competitors are even larger, with the E.U. shrinking by 25%, Korea by 30% and Japan by a remarkable 44%.”

Kotkin goes on to remind us how wrong the punditry has been in past cycles. Remember when Japan was eating our lunch in the 1980’s?

“The Japanese experience best illustrates how wrong punditry can be. Back in the 1970s and 1980s it was commonplace for pundits–particularly on the left–to predict Japan’s ascendance into world leadership. At the time distinguished commentators like George Lodge, Lester Thurow and Robert Reich all pointed to Europe and Japan as the nations slated to beat the U.S. on the economic battlefield. “Japan is replacing America as the world’s strongest economic power,” one prominent scholar told a Joint Economic Committee of Congress in 1986. “It is in everyone’s interest that the transition goes smoothly.”

He (Kotkin) then reminded all of us what could go wrong with China’s economic miracle and then shared his opinion of the future.

“China’s social problems will be further exacerbated by a huge, largely ill-educated restive peasant class still living in poverty. Of course America too has many problems–with stunted upward mobility, the skill levels of its workforce, its fiscal situation. But the U.S., as the Japanese scholar Fuji Kamiya once noted, possesses sokojikara, a self-renewing capacity unmatched by any country.”

“As we enter the next few decades of the new millennium, I would bet on a more youthful, still resource-rich and democratic America to maintain its preeminence even in a world where economic power continues to shift from its historic home in Europe to Asia.”

Are the pessimistic and dour pundits of today right this time? Should we be congregating our investments in the BRIC countries (Brazil, Russia, India and China) or dialing down our expectations for investment returns in the US investment markets because the inevitable “declinism” of the US economy has set in? This “group think” robs investors of the urge to concentrate on the strong balance sheet, wide moat and powerful brand companies which weather recessions and have more potential to be “Hall of Fame companies”. We believe anything that stops us from owning some of the best companies in the world this close to the aftermath of a terrible consumer-led recession is robbing us of future success.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

The definition of insanity is doing the same thing again and again and expecting a different outcome. At Smead Capital Management we want to spend most of our time talking about Hall of Fame companies this year. However, we feel we need to comment on the current stock market pullback because in some ways it appears to border on insanity.

A little review is necessary. A near complete panic and financial meltdown was averted by aggressive action on the part of the U.S. Treasury and the Federal Reserve Board in the fall of 2008. The liquefying effects of the stock market sell-off, the flight to quality in Treasury Bills/CD’s/money-market funds and low Fed Fund rates set up a very favorable yield curve designed to allow the major financial institutions to earn back the capital lost in the sub-prime meltdown. Sales of discretionary items fell off a cliff in the “reset” and the economy contracted by about 6% in the fourth quarter of 2008 and the first quarter of 2009. Financial sins have been confessed by the Federal Government, State Governments, Financial Institutions, Non-Financial Corporations and on the US Household level. Out of all this came a peak in pessimism in March of 2009 that rivals any “Point of Maximum Pessimism” that we have seen in nearly 30 years in the investment business. A series of highly respected pundits, who correctly anticipated the grief and fallout three years ago, have been granted prophet status in the marketplace and have been singing doom ever since.

As is usually the case, the peak in pessimism coincided with the stock market bottom at around 670 on the S & P 500 Index. The market exploded to the upside and ran into its first minor correction in late June and early July of 2009. The conventional wisdom at that time was that we were having a “Bear Market” rally and that the economy would take years to turn. The highly respected pundits warned us that the economy and financial institutions would take years to heal and that we would do better to buy gold and Treasury bonds.

The market rallied smartly until the end of August as the news on the economy continued to improve and the worst of the problems with financial institutions seemed to be passing. Once again, doubts about the economic recovery created a sharp pullback in the stock market as the pundits expected the economic recovery to disappoint and for this to be a “Bear Market” rally. Everyone knew that September and October are supposed to be lousy months in the stock market. The pundits became more forceful, letting us know that the US economy is never going to lead the world anymore and reminding us that the Chinese economy is the place to be going forward.

Once again the “negative nabobs” were wrong and the stock market in the US rallied to 1150 on the S & P 500 Index through mid-January of 2010. Since then, many of the most popular stocks of the last year in Technology, Oil, Basic Materials and in Heavy Industry are leading another minor correction. The pundits are staring at 5.7% economic growth in the 4th quarter of 2009 (dramatically better numbers than any of the pessimists predicted) and are saying that it won’t last. They are saying that more shoes have to drop in Commercial Real Estate and that financial institutions will take many more years to heal than we expect.

Therefore, we seem to be getting another minor correction in a multi-year bull market in stocks for the same reasons as the ones we’ve already had. We believe this is true because the same logic is being used by the same people in the same way as all the other minor pullbacks. We expect this year to be favorable to owners of good quality, recession resistant US common stocks and to the US economy. Wouldn’t it be insanity to expect anything different?

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

Why do most people make money owning their home? Why do folks make money on company stock and ten-year options? The answer is they hold these investments for a long time. If you hold a sound investment for ten to twenty years you typically get rewarded quite well. However, most human beings never participate in an investment for twenty years in anything other than their home or a piece of investment property. Why do investors hold most investments for short time periods when all the evidence is that you get the greatest rewards for long holding periods?

Historically, homes have appreciated at around 5% in the U.S. and common stocks have gained around 10% from a combination of appreciation and dividends. Why do US households have most of their capital tied up in real estate? We believe the biggest factor is liquidity. The only investments folks hold for twenty years are relatively illiquid. The cost and hassle of buying and selling property causes people to hang on. The hassle of moving your residence and the added monthly payments of buying a new one preclude activity. The fact that the price is not printed in the newspaper every day and there isn’t a willing buyer every day causes longer holding periods. We at Smead Capital Management think people are better off for having invested in real estate for long holding periods.

This brings us to our theme for this year-Hall of Fame Companies. Hall of Fame Companies have unusual success, great consistency and long duration. Why haven’t more investors participated on an uninterrupted basis in the common stock of McDonald’s (MCD) or Disney (DIS) or Merck (MRK) the last twenty years? Why do investors put their investable assets with money managers, financial advisors or financial institutions which make no attempt to own the same good quality common stocks for a long time? We believe one of the main reasons is that these terrific companies and their common shares are liquid every business day of the year. Someone offers to buy your shares every day. The temptation to time the cycles or shorten the reward period is overwhelming.

The New York Stock Exchange reported in 2009 that the average holding period for common stocks dropped below a year for the first time since the late 1920’s. Since investors invest in their rear-view mirror and good quality common stocks have had one of their worst ten-year stretches in history, investors don’t believe that they can get a long-term reward from the very thing that they are the most likely to get it from. One of our main jobs as portfolio managers is to help these very liquid investments become illiquid. Most investors and money managers take their cue from stock market trends, economic growth expectations or views of the current political leadership. We want to shepherd folks through long holding periods with companies that fit our Eight Criteria. In the process, we believe we will be able to look back in twenty years and realize that our client’s wealth has been determined by the companies we own which end up making the Hall of Fame.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.