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ValueInvestor

May 28, 2010

The Leading Authority on Value Investing

INSIGHT
F E AT U R E S

Wealth of Experience
Experience is only valuable if you learn from it. Five top investors share their insights on applying yesterday’s key lessons to today’s opportunities.

Inside this Issue
Investor Insight: Looking Forward Top investors share lessons learned from the recent past and ideas for the future, including Hartford Financial, Lazard, Harman and RHJ. PAGE 1 » Investor Insight: Kovitz Investment While looking to sell to optimists and buy from pessimists, finding value today in Walgreen, Lowe’s, Bank of New York and Wells Fargo. PAGE 1 » Uncovering Value: Natural Gas Do the virtues of natural gas as an energy source translate today into investment opportunity? PAGE 20 » Uncovering Value: SuperInvestors The 20 biggest bets being made by the leading investors tracked by PAGE 21 » SuperInvestor Insight. Editors' Letter Insight from a prosaic section of a company’s annual report. PAGE 22 »
INVESTMENT HIGHLIGHTS INVESTMENT SNAPSHOTS
Bank of New York Mellon Harman International

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vents of recent weeks have made it clear that “normal” is likely to remain an elusive concept for investors in the aftermath of the shocks delivered to markets by the financial crisis. Despite the comeback since March 2009, for most value investors the wounds from painful losses are still fresh, while divining the future for their portfolio holdings has never been more difficult. Which made it an ideal time to ask five top investors – with more than 150 years of collective experience – to share their insights on the lessons learned from the crisis, as well as on the risks and opportunities they consider most important today. While consensus on the lessons is fairly common, opinions diverge widely when it comes risks and opportunities. See page 2

LOOKING BACK« LOOKING FORWARD»
Applying yesterday’s lessons
to today’s opportunities:

James Montier GMO Charles Akre Akre Capital Robert Olstein Olstein & Associates John Rogers Ariel Capital Management David Marcus Evermore Global Advisors

Keeping a Level Head
The key to success for investors Mitchell Kovitz and Jonathan Shapiro: Aspiring to be “reasonably certain of a good result rather than hopeful of a great one.”
INVESTOR INSIGHT

PAGE 17 7 5 10 16 20 11 15 18

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Kovitz Investment Group Jonathan Shapiro (l), Mitchell Kovitz (r) Investment Focus: Seek high-quality companies whose attractive long-term prospects appear unreasonably obscured by the market's short-term concerns.

oncluding that life as a tax accountant wasn't for him, Mitchell Kovitz needed an “in” to break into the investing business in 1989 and found it in his father, who hired him at Chicago's Rothschild Investment Corp. “I got into the business the old-fashioned way,” he says, “through nepotism.” Kovitz has more than earned his place. The equity composite of separately managed accounts he has run since 1997 – now for his own firm – have earned a net annualized 10.2%, vs. 5.4% for the S&P 500. Finding much better value today in higher-quality rather than lower-quality stocks, he and partner Jonathan Shapiro are focusing on leaders in such markets as pharmacies, home-improvement retail, financial See page 13 services and banking.
www.valueinvestorinsight.com

Hartford Financial Lazard Lowe's Range Resources RHJ International Walgreen Wells Fargo

Other companies in this issue:
Bilglari Holdings, BP, CIT, Coca-Cola, Dollar Tree, Hewitt Associates, JPMorgan Chase, Lloyds, Lockheed Martin, Macy's, Northrop Grumman, OPAP, Owens-Illinois, Penn National Gaming, Ross Stores, St. Jude Medical, Sears, Siemens, SLM, Teradata, TJX, Total, TransDigm, Valeant, Wal-Mart, WMS Industries

I N V E S T O R I N S I G H T : Looking Back, Looking Forward

Investor Insight: Wealth of Experience
James Montier, Charles Akre, Robert Olstein, John Rogers and David Marcus describe the lessons reinforced for them by the financial crisis, their general views on the investment opportunity set available today, and why they're finding specific opportunity in companies such as Hartford Financial, Harman International, Lazard and RHJ International.
INVESTOR INSIGHT

James Montier GMO “An even bigger surprise has been the willingness of investors to forget all the bad stuff and reprice assets so quickly.”

love the Austrians – it’s kind of like asking an Irishman for directions and he inevitably says, “Well, I wouldn’t start from here.” That’s really helpful, thanks. At least Keynesians offer up a solution, even though it’s unlikely to be painless. The problem is that we just keep kicking the can farther down the road. I guess the hope is that we can grow ourselves out of our problems, but there’s still far too much leverage in the system. It’s gone from a private-sector leverage issue to a public-sector leverage issue, but there’s still a leverage issue. That has all sorts of implications for the future, the most important of which is rampant potential inflation. But, as usual, investors seem to be ignoring the risks to a large degree. What makes you say that? JM: Within equity markets, I really can’t find a lot of value anywhere in the world, either top-down or bottom-up. Topdown, P/Es based on long-term historical earnings show equities overall trading at 22-23x earnings, against an average over time of 17x. That’s expensive – in the top quartile, historically – but not yet insanely so. That doesn’t mean stock prices won’t go higher, but it probably means returns from these prices are going to be pretty inadequate relative to the risks taken on. From the bottom up, I’m getting very few hits in my value screens. The last time I did it there were just eight stocks passing my favorite screen in the U.S. and Europe (see table, next page). There’s some real muck on the list, but a few of the interesting ones are oil companies BP and Total, as well as the Greek state lottery operator called OPAP. BP was not a big surprise given all the problems they’re having at the moment, and it may signal a classic case of overreaction to shortterm bad news. OPAP strikes me as not a
www.valueinvestorinsight.com

bad business, but even as contrarian as I am, I’m not sure I’d fancy being in Greece at the moment. In any event, there are just a handful of these types of value opportunities. That’s quite a contrast to late 2008 and early 2009, when we were kind of spoiled for choice. Even things like Microsoft, which as a deep-value guy I never imagined I’d get the opportunity to buy, were showing up on this type of screen. With the markets having rallied so hard and so fast, most of that valuation support has been strip-mined out. One lesson you consider unlearned from the crisis has been that “macro matters.” What macro issues should be top-of-mind for investors today? JM: The really big one has to be inflation – how it occurs, what it means to an investor and how to protect a portfolio from it. As we move from a private-sector credit bubble to a public-sector credit bubble, the dangers associated with that tend to be inflationary in nature. Governments tend to like to inflate away the real value of their debt – it’s always a tempting policy option to effectively debase your currency in the face of big debt problems. I’m not sure investors are thinking enough about that. I’m sympathetic to the notion that it’s hard to imagine rampant inflation with unemployment so high and so much excess capacity in the system, but I think people underestimate the speed at which inflation can return if the velocity of money starts to stabilize and then pick up. If banks just start lending a bit more, you can get very quick transmission from base money creation straight away through to prices. The second big issue is whether we’ve yet created another bubble in equity prices. It’s too early to say, but one would
Value Investor Insight 2

The world was collapsing when we last spoke 18 months ago [VII, October 31, 2008]. Has anything surprised you about the evolution of the crisis and investor behavior since then? James Montier: The willingness of the authorities to react to the crisis and the extent to which they did so was a huge surprise. It’s a credit to how seriously they took the threats posed by the danger of deflation in an overleveraged system. An even bigger surprise – the latest unpleasantness notwithstanding – has been the willingness of investors to forget all the bad stuff and reprice assets so quickly as if all is well and good and there won’t be consequences of this huge policy response. It’s rather staggering. Would you have argued for a different policy response? JM: In many ways, massive fiscal and monetary intervention was probably the only policy option. I wouldn’t advocate that we should have publicly flogged ourselves, which would have been the Austrian School response. You have to
May 28, 2010

1x 12.03 "Graham & Dodd" P/E (1) 2. We’ve found that dividends and inflation are highly correlated at anything beyond a five-year or so time horizon. Belgium U. high-quality stocks as being particularly attractive. with covenant-lite and payment-in-kind bonds reappearing. I did end up buying some. short nominal bonds as a protection against inflation. of course.9x 10. which is exactly the world we face. Those are reminiscent of the total absence of fear we saw in 2005.6x 11. which is never really likely to generate great returns. for example.7x 12. which investment banks put together to allow investors to buy just the dividend streams out into the future of indexes or individual companies. What’s an investor to do? JM: We’re not yet in a situation where I would say to abandon hope. The nice thing about that is that the cost of carry is generally not too high.7x 11. If you look over the past decade. European dividends have grown something like 4% per annum in real terms over the past 30 years. although I’m finding we’re in that in-between phase at the moment where not much is showing up on my long or short screens.S. particularly in a world in which you’re seeing competitive devaluations.4x 9. 2006 and early 2007. and Europe currently pass James Montier’s valuation screen that identifies companies trading with an earnings yield of twice the AAA-bond yield. Stock Price@ 5/27/10 £8. While gold has attractive properties.9x 9. then gold would act as a store of value while the financial system disintegrated. U. a dividend yield of at least two-thirds the AAA-bond yield. the bugbear for me is that I still don’t know how to value it. A rerun of a generalized bubble in risk isn’t much fun for those of us who are conservative by nature. Looking Forward be tempted to suggest we might be on the way to one. Company Fresnillo OPAP Total Parmalat GAME Group Solvay BP Keller Group Ticker FRES:LN OPAP:GA TOT PLT:IM GMG:LN SOLB:BB BP KLR:LN Country Mexico Greece France Italy U. which means the maximum I can lose on shorting something like a Japanese government bond today is around 13%. Commodity markets have been changed dramatically by the presence of investors. One should also have exposure to inflation protection. There are some opportunities – GMO still identifies large-cap.1x Notes: (1) P/E based on 10-year average of historical reported earnings Sources: James Montier. that’s gone up to one in two. One I ran the other day on worsening fundamentals had some oddities show up. which meant people with no commercial interest in the underlying asset. I’m essentially able to buy the cash flows of companies without having to worry about the multiple the market places on them at any given time.23 $45. say. we know people use gold as a store of value during inflationary times. Have your views on gold changed? JM: Gold still vexes me terribly. Are you still actively screening for shorts? JM: I am indeed. although the yields are so low as to be uninteresting in most places. You’re also seeing some risk-loving behavior returning to debt markets as well. Australia and New Zealand still have some index-linked bonds with relatively high real yields.84 €1. publicly available information May 28. If the world went into deflation. with total debt less than two-thirds of tangible book value. which I need to look into further. GMO.38 £6. One can also. Based on CFTC [Commodity Futures Trading Commission] data. For those who have to be invested in equities. in the early 1990s only one in four market participants were so-called speculators. Yields essentially can only go as low as 0%.91 €71.valueinvestorinsight.K. the giant brewer. so we’re seeing interesting opportunities in longer-term swaps on. Value Investor Insight 3 Slim Pickings Only these eight stocks trading in the U.83 €12. All the bailouts appear to have created another bout of moral hazard in markets. making it more of an over-crowded.38 $47. The most obvious and least inspiring method for doing that is TIPS [Treasury Inflation-Protected Securities]. In recent years. but I’ve concluded it has a place in an inflationprotected portfolio. I believe we also spoke last time about dividend swaps.I N V E S T O R I N S I G H T : Looking Back.94 £0. because they’re so popular. which is a bonus in the wonderful world of shorting. because I thought it offered opportunity under two extreme outcomes.com . companies with low leverage and stable and high ROE’s – the Microsofts and Pfizers of the world. the Euro Stoxx 50 Index. investordriven market. and you have a known and limited downside. 2010 www. which strikes me as a poor outcome. including SABMiller. How much am I really paying for protection against these catastrophic outcomes? Not knowing what it’s worth makes gold somewhat uncomfortable for me to own. What about other commodities? JM: I’m generally quite worried about those. On the other side. and with a P/E of no more than 16x a 10-year historical average. investors in commodities have managed to earn essentially bond returns with equity or greater volatility.K. offering both inflation protection and potential real growth. if you like – make a great deal of sense.K. but it’s certainly a time for relative conservatism.

that means having a dedicated and consistent short strategy.to low-single digits.S. but you need to have a clear understanding at a portfolio level of what your exposure to it is. In our partnership. 2006]. and we didn’t recognize the repercussions elsewhere if housing did. and they have rebounded the most as the market has come back. When making bets on what will happen. That can mean many things. We still invest in one business at a time. INVESTOR INSIGHT old ones. As the market has taken off. because it has short-term negative cash flow and there’s a real chance you won’t have needed it. We ended up doing well on it – selling at $16-17 after it had come back from going as low as $3 – but if I had connected my broader concerns to my specific ones about something like AmeriCredit. How would you rate your performance on those fronts through the crisis? CA: My biggest self-criticism is that I didn’t connect all the dots with respect to broader concerns I had. But I would say I’m still more focused on the headwinds rather than the tailwinds. I consider it a good way to protect oneself against ignorance and uncertainty. The federal debt is already at an unsustainable level. It can mean low-cost ways of protecting yourself against inflation. by the end of this year $2. When we first spoke [VII. Another lesson is the primary impact on investment returns of the financial leverage of the companies you own. But we didn’t act on that with enough conviction on the short side. 2010 . In 2005 we did a lot of work on companies leveraged to easy credit and the housing boom and came away convinced they were headed for trouble.valueinvestorinsight. and I have to believe taxes in every possible category are going up next year.” You’ve been at this for more than 40 years. One thing I do think more about is the role in one’s portfolio of cheap insurance against the ignorance that manifests itself from time to time in the market. which still drives 70% of domestic economic activity. All this makes it a bit hard for me to be enthusiastic about consumer spending in the U. Related to all this is just making sure you construct your portfolio in such a way that when there’s a severe decline. but I don’t mind deploying some of that cash to buy out-of-themoney call options. According to Meredith Whitney [of Meredith Whitney Advisory Group]. both of which seem to abound in the world I see at the moment. but I’d have to say it wasn’t particularly top-of-mind before the trouble hit. it means focusing only on companies and businesses we absolutely understand and for which we have the highest conviction. and our cash levels are higher than they’ve ever been – 20% in our partnership. I’ve obviously struggled with whether I’m overreacting to potential concerns. Much to our chagrin. It also means retaining enough flexibility and liquidity in the portfolio that we aren’t forced to stray from our discipline at the exact moment we shouldn’t.S. it’s very important to consider all that can happen. which is maybe cause for worry. unemployment and underemployment are still very high.com bought as far back as 2002 in the mid. particularly about the housing market. It had risen to the mid$20s. Given that. Looking Forward You’ve been pretty right about things in the past couple of years. We’ve heard Warren Buffett and Charlie Munger talk about that and I’ve reminded my clients of it from time to time. Did any new investing lessons come out of your experience of the past two years? Charles Akre: They aren’t so much new lessons as they are the reinforcement of May 28. That’s not to say leverage is inherently bad or good. for example.7 trillion will have been removed from credit card lines of credit and home equity lines. Value investors tend to hate insurance. protecting me somewhat against risk-living behavior running much longer than I think it should. which drives 70% of economic activity. you are less likely to react emotionally to it. It’s pretty straightforward: the companies with the most financial leverage declined the most when the market tanked. we haven’t done a lot of buying since the market bottomed in March 2009. in fact. I’m not finding much to buy and am therefore inclined to hold cash. In all our portfolios. we found out.. What are the key elements of your worldview today? CA: There’s no question that certain parts of the economy are recovering. and we’re finding valuations on a lot of businesses that are very reasonable. One is that if you own common stocks. November 30. except for businesses that cater primarily to the more cashstrapped buyer. we would have avoided a lot of pain. or whether I’m just being prudent and the market is Value Investor Insight 4 Charles Akre Akre Capital “It’s a bit hard for me to be enthusiastic about domestic consumer spending. The levels of U. crack.I N V E S T O R I N S I G H T : Looking Back. they will periodically go down 50%. We’ve also significantly lowered our exposure to consumer spending. but have you reevaluated any part of your own approach based on recent experience? JM: Not really. but we’re trying to better integrate what I’d call our worldview into our individual stock analysis and selection. but I never allowed it to become a core 5-10% position because I couldn’t be certain how it would behave in an adverse environment. I mentioned AmeriCredit. It can mean today having positions that benefit in case the market resumes its melt up. a subprime auto lender whose stock we’d www.

I’m still fairly confident it’s the latter.0% 120 100 80 60 40 20 0 Revenue Operating Profit Margin Net Profit Margin HIG PRICE HISTORY 120 100 80 60 40 20 0 2008 Shares Short/Float 2009 2010 THE BOTTOM LINE The company’s competitive strengths and recapitalized balance sheet should allow it to steadily prosper as the economic climate improves. almost twice the normal level. Even with all that. says Chuck Akre. you have more state and local governments casting aside reservations about gaming in order to raise money in difficult financial times.46 0.5% 3. It’s a supplier of gaming machines. has $520 million in net cash.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 25. Looking Forward the one overdoing it. It has a strong brand name.20] it’s trading at less than 11x our 2010 free cash flow estimate of $5 per share. Dollar Tree [DLTR] and TJX [TJX]. Ross. so should benefit from the rollout of new gaming venues in new geographies.50. CA: This is a good example of what we're finding interesting given our outlook.7 13. The only other exposure we have in gaming is in WMS Industries [WMS].00 – 30.9% 3. Sources: Company reports.63 billion 5.com Value Investor Insight 5 . which sells both soft and hard goods.6% 2. but now it’s down to about 3.33 billion $25.7% 3. both in the U.S. [at a recent $53. with upside beyond that as insurance-company valuations recover.valueinvestorinsight. with a dividend of $1.8125 per share.52 10. and internationally. Three of our top ten holdings are offprice retailers. and we believe should increase free cash flow per share at a mid-teens rate over the next five years. These shares currently trade at $22. He expects its convertible preferred shares to generate nearly 20% annual returns to their 2013 conversion date. That’s going to mean more competition for companies like Penn National. Even after a nice run for the stock. We also believe that before long there will be a more robust replacement cycle. Why? The company still has plenty of runway for growth. For the time being. but the convertible preference shares (ticker symbol HIGA) that were sold as part of a recent INVESTMENT SNAPSHOT capital raise. a large customer base and excellent distribution.7384 shares of common to one share of the convertible preferred. Share Information (@5/27/10): Trailing P/E Forward P/E Est. While each clearly relies on discretionary consumer spending. The company was a TARP recipient.5%. CA: One long-time holding of ours is Penn National Gaming [PENN]. given that the average age of existing machines on casino floors today is something like eight years. Each share mandatorily converts into common in April 2013 at a ratio of 0. The areas Hartford Financial Services (NYSE: HIG) Valuation Metrics (@5/27/10): Business: Provider of a full line of life insurance.6% 2. On top of that. We don't own the common. for individual and commercial markets.50] is selling at only 11x this year’s estimate of free cash flow. I don’t see that turning around any time soon. has increased its dividend by more May 28.50. Dollar Tree today [at $62. a well-diversified portfolio of insurance and investment products and services. When we last spoke. and that free cash flow has grown over the past ten years at a compounded 16% per year. and given my views on consumer spending. we expect them to continue to expand their reach as consumers actively seek out less-expensive options for buying necessities and nonnecessities alike. other publicly available information www. which I believe has been the best compounder of shareholder capital in the gaming industry over the past 15 years. Describe what you find attractive about Hartford Financial Services [HIG].7 S&P 500 17.5% Company Wellington Mgmt Vanguard Group Fidelity Mgmt & Research NWQ Inv Mgmt Paulson & Co Short Interest (as of 5/14/10): % Owned 6. property/casualty insurance and asset management products and services.2 8. Ross Stores [ROST]. and now appears to be well capitalized. 2010 than 20% per year over the past five years. So from today's preferred-share price. (@3/31/10): HIG 300. the conversion equivalent value is $30. but visits to casinos and play per visit have been down for the past two years. Give some examples of how your concerns about the consumer are manifested in your portfolio. Our thesis is relatively simple. Penn National made up well over 10% of our portfolio.7% 4.I N V E S T O R I N S I G H T : Looking Back. has since restructured its balance sheet.8% $11.

From today's price. but I would be very surprised if we see again in our lifetimes the unique set of circumstances that played out from the fall of 2008 through the spring of 2009. we looked ahead to the better pricing environment in the future that would result. In many ways. of course. As earnings increase from $2. Hartford's pro-forma tangible book value was right around $30 per share. If the growth we expect in tangible book value occurs. In the end. In our partnership. 2005]. Then Lehman goes under and all bets are off.50 per share this year to $4 per share and up in 2011 and 2012. you talked about having managed through five market corrections of 25% or more. and an important reason was that we weren’t focused enough on it. don't do a thing. We think the stock is worth at least in the low $30s. Move ahead to 2008 when panic goes into financial stocks after Bear Stearns has to be “saved. Never say never. You can’t throw out your whole strategy because of a once-in-a-lifetime event. You’ve recently been critical of what you refer to as the “daily blab” of market reporting. in addition to Citi. www.I N V E S T O R I N S I G H T : Looking Back. Let me provide some perspective on why I say that. We still have it in the portfolio at close to $70. we saw that as an opportunity for it to pull back on investment spending and work on increasing profitability at the store level. we expect tangible book value at the time of conversion to be in the $40 range.” For all but the smallest percentage of people involved in the market. and we’re looking at other ways to build our proficiency there. and conclude that its basic spread business – the difference between where it borrows money and where it lends it – is generating $3. because we didn’t believe oil would possibly stay at $10 per barrel and the prices of the stocks were well below the salvage value of the equipment. Looking Forward targeted for growth – small and mid-sized company P&C insurance. then.75 per share in earnings.” I see that all happening and get interested.5:1 total assets to Value Investor Insight 6 . since I’ve seen that kind of panic before. Goldman Sachs and American Express – taking huge losses even though we had gotten in after they were already down 50%. 2010 CA: There is still a large and loud industry out there which on a daily basis tries to advise anyone listening exactly what they should do today – often right now – to be a better “investor. we're getting a better than 8% annual dividend yield and a total cost-toconversion gain of 35%. So we were buyers in 1998 of drilling companies when oil was at $10 per barrel. Confidence in the system is shot and we’re looking at a nasty period of deleveraging and massive capital raises. September 28. Given the terms on the convertible shares. we believe we're being amply paid to wait. that’s bad for you and is not the way to build wealth over time. When capital was being pulled out of the insurance industry after 9/11.” In our last conversation [VII. Then. down from $60 to $23. Our discipline of stepping up when we thought the market was overreacting – the playbook that had worked my entire career – did not work because our thesis that the government would not allow a big bank to fail was wrong.com When McDonald’s stock was in the mid to low teens in 2003 and everyone was concerned that its growth was over. we now have four positions at 10% or more of the portfolio. its industry or the market overall. How does the correction of 2008 and early 2009 compare? Robert Olstein: I’ve been in the business for 43 years and have never been through a period so scary. Your portfolios have typically been highly concentrated. wealth management and risk protection for members of affinity groups like AARP – all make sense to us. INVESTOR INSIGHT Robert Olstein Olstein & Associates “We can feel the same emotions as the small investor – when you're in that state of mind. When times are better – we're in the fourth consecutive year of soft pricing in the property/casualty business – companies like this historically sell for solid premiums to book. the system failed. and we think they’re marking down assets too much based on market pricing that has unhinged from reality. you should have enough money behind them that good results really impact your returns. things like Morgan Stanley. does that make me question the discipline? No. We analyze something like Citigroup. Why? May 28. Our investment strategy is based on buying at a discount to the intrinsic value of a company. I myself am spending more time on shorts than I once did. One process change I am still working on is to devote more resources to the short side in portfolios in which we short. Are they still? CA: Nothing about our experience of the past two years has changed my conviction that when you’ve identified businesses that can compound capital at high rates and you don’t have to pay too much for them. That’s obviously an uncomfortable situation for an investor. Reserves had been raised to an all-time high. We blew out of every financial we owned – including. Have you made any less-dramatic adjustments in how you do things? RO: We do have a new rule: Any position with more than 2. which arises when there are concerns about the company. At the time of the recapitalization in March. We weren’t short enough going into the crisis. we're looking at a theoretical annual return of around 20%.valueinvestorinsight. something good could happen beyond that.

3% 4. That has all worked pretty well. we did buy asset managers such as BlackRock.93 – 53.71 16. Sources: Company reports. but even at today’s price [of $22] trades at less than 8x estimated 2010 free cash flow of around $2. and which we expected to hold up much better if the market had stayed in the tank. Are you still counting on that with Harman International [HAR]? RO: This is a classic opportunity for us.S.0% $2.4% 7. That’s a free cash flow yield of nearly 13%. The rationale is simple: When you’re wrong with a leveraged business model. Consistent with our strategy over time.valueinvestorinsight. We were getting at least 30% discounts to intrinsic value on stocks that for 30 years had been too expensive. and are more exposed to growth outside the U.I N V E S T O R I N S I G H T : Looking Back.0%) Company Fidelity Mgmt & Research Capital World Inv Artisan Partners Vanguard Group Wellington Mgmt Short Interest (as of 5/14/10): % Owned 8. consumer and professional markets. the stock would be worth at least $50.4% (-1. Teradata [TDC]. which make a lot of their money from reusable medical products. It’s actually amazing to me how overpriced so many small and mid-cap stocks are today relative to companies like Intel and Microsoft. They typically pay solid dividends. Procter & Gamble. (@3/31/10): HAR n/a 35. We’re not just in the biggest names in technology. its size in the portfolio is capped at a low level. but we’re still using high-quality megacaps as stabilizers of the portfolio.36 0. professional and consumer markets in the United States. You’ve typically found upside in potential turnarounds.2 S&P 500 17.com Value Investor Insight 7 . If it is an exception. What’s been your strategy as it has risen from the depths? RO: All the forced selling gave us opportunities we hadn’t seen for some time to buy large. well-capitalized blue chips like Coca-Cola. $7 and $8.S.3% 5. which we INVESTMENT SNAPSHOT bought at $6.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 32. It had been a highflier in the mid-2000s.27 billion $3. Looking Forward shareholders’ equity is an official exception to our methodology. Dickinson and Covidien. At a reasonable 15x the $3. while we stayed away from the large banks.7 13.50 per share he believes the company can earn by 2012. manufactures and markets audio and electronic systems. we’re also finding opportunity in companies for which reported earnings appear to underestimate cash-generating power. primarily to automotive. Another theme we went after were healthcare companies that would be primary beneficiaries of more patients entering the system. has an impeccable balance sheet and can grow revenues at least at a high single digit rate going forward. after adding back excess depreciation. says Robert Olstein. which we thought would do very well as the market stabilized and eventually turned up. Why would you pay 30x earnings for an economically vulnerable company with a mediocre balance sheet while walking May 28. 2010 away from Intel at 10x earnings? It just makes no sense to me. AllianceBernstein and Legg Mason. A great example is Macy’s [M]. We also won’t have more than 10% of the portfolio overall in such exceptions.2% 2. Intel and Microsoft. The company sells a wide range of audio and infotainment systems for auto. even if you got a bigger discount. other publicly available information www.6% 4. but relative to the prices being paid in the market. Share Information (@5/27/10): Trailing P/E Forward P/E Est. Also. That led us to companies like Becton.21 billion 2. Your flagship fund is up more than 80% since last year’s low. the descent in the stock price can just be too fast and too damaging.80.4% 120 100 80 60 40 20 0 Revenue Operating Profit Margin Net Profit Margin HAR PRICE HISTORY 120 100 80 60 40 20 0 2008 Shares Short/Float 2009 2010 THE BOTTOM LINE A broad-based operational restructuring should give the company significant operating leverage as it benefits from market-share gains and a general recovery in its primary automotive markets. which is in the data-warehousing and data-mining business. that we expect will far exceed growth in the U. with Harman International (NYSE: HAR) Valuation Metrics (@5/27/10): Business: Develops. Are the easy finds gone? RO: The discounts are now down to 1015%. it trades at a 25% discount to what we think it’s worth.

and some of the banks. the operating leverage built into the company should generate much higher profits. One critical thing I’ve learned. It’s not possible to avoid it eating at you emotionally when the market is going against you. how are you looking at valuation? RO: By 2011 or 2012. We also didn’t let the pain of the decline keep us from buying our favorite stocks as they got cheaper and cheaper. We had followed Harman for some time and were impressed with the innovation of its products and its growth prospects. Value Investor Insight 8 . 2010 ending in June 2010. In general. How early did you buy into the turnaround plan? RO: We started building our position last September at approximately $30 per share. which is not typically the case. After one failed attempt at a new CEO. The standouts for us over that time were Gannett. but we did a very good job avoiding the financial companies that could – and. we think the business will deserve a multiple of 15x or so. the newspaper publisher. Balance sheets today are very liquid and I’m as likely to find companies with free cash flow above reported earnings than below. don’t do a thing. That gives us a downside only in the high $20s. we believe the company on revenues of around $4. If we’re right about earnings.50 per share. but the hard part is to stick to your guns when the crowd’s running over you. I don’t make decisions. and higher-end retailers like Nordstrom and Tiffany. we see $2 per share in earnings as a bad-case scenario. You can basically do three things in such a situation: sell. and instilling an ethic of cost-control and productivity that had never been there. which would translate into a share price of at least $50 in the next 18 to 24 months. real estate services companies like CB Richard Ellis and Jones Lang LaSalle. however. which is where a private equity deal to buy it was announced in 2007. www. as it turned out in some cases. We lost some longtime clients. the board hired Dinesh Paliwal in mid-2007. From the market bottom on March 9. 2009 our largest mutual fund. As they take share in an auto-sale market that continues to revive. but stayed away from them when it counted because we didn’t overly discount the fact that these types of companies. that Harman is proving to be the go-to provider. With the shares now around $32. Looking Forward the stock going from $30 (split-adjusted) to around $120.2 billion should be earning at a rate of maybe $3. but only assumes the company gets back to 8-9% operating margins. number one. did – spiral down to nothing. but in these cases. particularly in China and elsewhere in Asia. vs. The deal fell through and the economy tanked.70. with net cash of $240 million. Revenues tied to the auto business account for about 70% of the total.com INVESTOR INSIGHT John Rogers Ariel Capital Management “Looking out more than a year. we could have assumed the worst expectations were being overdone. and he finally started putting in place the basic operating discipline the company desperately needed – closing high-cost factories. the 12% at which it’s operated in the past. was up more than 150% through the end of April. being more disciplined about capital allocation. dumping unprofitable product lines. one of which delicately referred to me as a “washed-up All Star” as the market was going down. there are plenty of values out there. how high is that quality today? RO: It’s actually about as high as I can remember. Through the downturn it took market share and it has announced several new-business wins.valueinvestorinsight. the more people stretch to justify their stock prices. could literally go away. which accelerated our comeback as the market turned up. and number two. The problem was that the results of all that got overwhelmed by the terrible economy. had ruled with an iron fist and just wasn’t the guy to manage it as it grew so big. In most cases we bought more. We did a lot of work on companies like Countrywide. What’s the downside if you’re wrong? RO: The balance sheet is in excellent shape. thankfully. and we like.” Was that particularly hard this last time? RO: It’s never easy. That’s partly a function of the market not being overly frothy – usually the higher the market goes. The founder. that automobile consumers continue to demand more sophisticated entertainment systems. or buy more. particularly in what we consider light cyclical stocks. When we spoke last time. We can all feel the same emotions as the small investor – when you’re in that state of mind. Sidney Harman. for which we’d expect the market – or an acquirer looking to buy what is truly a unique product portfolio – to pay at least a 14x multiple. you said: “This is not nuclear physics.I N V E S T O R I N S I G H T : Looking Back. but always thought it was poorly managed. With all the operating efficiencies. As dyed-in-the-wool contrarians. You’ve made your name assessing the quality of earnings. we didn’t.” Where do you give yourselves high marks in navigating the crisis? John Rogers: We’ve traditionally been active investors in financial services. taking the shares below $15 at the height of the crisis. is that whenever I’m the least bit emotional. the Ariel Fund. MBIA and Ambac. hold what you have. That’s up from around $1 per share estimated for the fiscal year May 28.

valueinvestorinsight. which provides advisory services to companies in financial distress. Looking out more than a year.S. but the crisis has only reinforced the importance of being certain that even the greatest business you’ve identified can’t be driven into the ditch because of risks on the balance sheet. which is hard to truly have unless you’re really out there yourself. We think we’ve always been conservative.Rowe Price [TROW] and Janus [JNS]. Hewitt’s business-process outsourcing division has been a drag on operations over the past few years. with three legs underpinning its business. We think that business has stabilized. which you recommended when we first spoke [VII. Another thing we’ve worked on. and has excellent growth potential as cost-conscious companies continue to outsource administrative HR tasks. and as some of the enormous amount of private-equity cash out there starts to be deployed. Is that still the thesis? JR: That. Describe what you find interesting about Lazard? JR: Lazard is the world’s largest independent financial advisory firm. which had around $135 billion in assets as of the end of March. it has been quite successful in creating and selling global and non-U. Have you made any strategy or process adjustments in the aftermath of the crisis? JR: We’re putting increased importance on our senior portfolio managers being fully engaged in the ongoing dialog with management. The second leg of the business is asset management. a result of the company emphasizing market share over profitability in taking on earlier big contracts. The market doesn’t seem to have bought into that yet. In the restaurant-equipment business we like Middleby [MIDD]. One key aspect of this is looking closely at what the credit markets – for example. which suffered in the crisis. T. The crown jewel of the company historically has been its mergers-and-acquisitions advisory practice. A second broader problem was that if you’ll remember. The first two have kept it in the game through the crisis and the third is a big reason we think the stock is undervalued. as I’m sure many have. media was considered this great cash-flow business. which positions it perfectly as more deals get done. especially during times of stress.40] trading at around 11x the consensus $3. Looking Forward Where have you been critical of yourself? JR: We didn’t manage our exposure to media companies well. Given the company’s global footprint. those more leveraged media companies got particularly slammed. Lazard specializes in advising large-cap. Where are you seeing opportunity today? JR: We’ve been increasingly optimistic that the economic recovery is real. we believe there are plenty of values out there. In our newspaper holdings. which is wellpositioned to benefit as people start eating out more as the economy improves and delayed restaurant capital improvements get made. which May 28. cross-border M&A transactions. requires conviction.I N V E S T O R I N S I G H T : Looking Back. as well as the fact that the human resources-related consulting expertise Hewitt is known for is more important to companies than ever. is much better managed. expertise and reputation that Lazard has in the deal business. balance-sheetaware investors. in terms of bond or CDS prices – are saying about the companies we own. is to tighten up our balance sheet analysis. 2010 should lead to upside surprises in select areas. cash-rich companies look to improve their competitive positions. our newspaper stocks got hit pretty hard. as well as having to deal with significant changes coming out of Washington in areas like executive compensation and healthcare. which we believe are going to accelerate from an already picked-up pace as economies mend. so companies got comfortable with higher leverage to finance acquisitions or in some cases to appease shareholders through stock buybacks or increased dividends.25 per share earnings estimate for 2011. That’s not something to delegate and then read a report on. Successful investing. October 30. When the recession hit. That’s a function of the need to compete in an increasingly global competitive environment. we didn’t put enough weight on the erosion in classified advertising that just wasn’t coming back due to competition from the Internet. particularly in what we consider the light cyclical stocks. and would expect restructuring to be a core area of growth over the next few years as companies work through damage done by the economic crisis. You’re still a large holder of Hewitt Associates [HEW]. www.com . We don’t think any investment bank has the combined contacts. A great example of this is the company's recently being named to manage General Motors' public offering. Those include companies in financial services such as Lazard [LAZ]. investment products – particularly those investing in emerging markets – which is where the most attractive growth is likely to continue to be in years ahead. When that important secular decline was combined with the terrible cyclical downturn in advertising spending. It surprised people that Value Investor Insight 9 ON PROCESS: I have to be fully engaged in the ongoing dialog with management teams – that’s not something to delegate. and industrials like Illinois Toolworks [ITW] and Idex [IEX]. attending conferences. with the shares [at a recent $37. management. Our fair value on the stock is closer to $60. 2005] as a beneficiary of the secular trend toward the outsourcing of corporate services. We believe their independence and experience in this business is a key competitive advantage. The brightest spot for Lazard has been the firm’s restructuring business. I have to be visiting people face to face. and sitting in on the conference calls.

says John Rogers.96 billion $1. If the party is in Asia. what’s www.96 25. making it a prime beneficiary of a more active deal environment.2% (-6. We have a resilient economy that over a long time – and through crises worse than what we’re currently experiencing – has always gotten back on track. strain and panic.6% 2.0 S&P 500 17.20 – 44. Looking Forward INVESTMENT SNAPSHOT Lazard (NYSE: LAZ) Valuation Metrics (@5/27/10): Business: Global provider of financial advisory and asset management services to corporations. Based on both DCF and sum-ofthe-parts analyses. but we think there are many more opportunities like that to come. spinoff.” 40 40 30 30 20 2008 2009 2010 20 THE BOTTOM LINE No investment bank matches the company’s contacts. are on their death bed? DM: The common market and common currency were created to allow greater competitiveness with Asia and the U. Sources: Company reports. the funeral is in Europe. the shares trade for 12x consensus 2011 earnings estimates of around $2. expertise and reputation in the mergers-and-acquisitions business. balance sheet reformulation or management change that we believe will be valuereleasing. At today’s price. (@3/31/10): LAZ n/a 15.S. operating turnaround. What’s the biggest investing lesson you’ve learned from the past two years? JR: It’s nothing people like Warren Buffett and Charlie Munger haven’t been saying for decades. INVESTOR INSIGHT Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 32.7 13. and it’s an excellent time for that now in Europe. which we think May 28. he believes the fair value of the shares today is around $53. and it’s an excellent time for that now in Europe. which is the importance of thinking long-term. That’s quite significant in the current environment. Focusing more on how that plays out than on what’s happening to your portfolio right now is just a far saner way to invest.valueinvestorinsight.5% $2. usually involving some combination of a restructuring. How much credence do you put in the argument that the European Union. strain and panic. which puts them at nearly a 40% discount.71 billion 7.7% 5.8% 6. including a traditional discounted cash flow analysis and a sum-of-theparts calculation based on market comps for their component businesses.com . Are you busy at the moment? David Marcus: Our strategy is focused on deep value with a catalyst.I N V E S T O R I N S I G H T : Looking Back.75 per share.2 Largest Institutional Owners most likely to happen is that you give up on the market at exactly the wrong time. Our fair value on the shares today is around $53. Rowe Price Pioneer Inv Mgmt Deutsche Bank Short Interest (as of 5/14/10): % Owned 6. We’re always attracted to where there’s stress.4%) Company Lord Abbett & Co Bank of New York Mellon T. governments and high-networth individuals. 2010 is likely to turn out to be conservative. honed over 14 years working mostly for Michael Price at Mutual Series. The Street isn’t giving them nearly enough credit for that.4% 60 Revenue Operating Profit Margin Net Profit Margin LAZ PRICE HISTORY 60 Shares Short/Float 50 50 David Marcus Evermore Global Advisors “We’re always attracted to where there’s stress.9% 4. and the euro. management. but if you get swept up in the daily or weekly ups and downs of the market. It’s hard for me to imagine that at a time Value Investor Insight 10 Lazard got the engagement.62 1. what upside do you see as that credit is earned? JR: We come at valuation in a variety of ways.4% 4. other publicly available information Your expertise. You may or may not be right about your long-term views. Share Information (@5/27/10): Trailing P/E Forward P/E Est. is in European distressed and special-situation investing. With the shares just under $33.

with the original charter to own undervalued Japanese industrials.5 million P/E RHJI n/a S&P 500 17. we’ll get the nice debt yield and have an equity kicker. We made it a big position INVESTMENT SNAPSHOT in January in the mid-€5 range and today it trades around €6. Looking Forward when that’s more important than ever that they’ll break it all up.90 – €6. Where are you finding more distressed situations of interest? DM: We’re hedging our bets.com Value Investor Insight 11 . but if we’re right about the extent of the change going on.33 €3. They can no longer be everything to everybody. merchant bank Kleinwort Benson. They are shedding businesses in which they can’t be leaders. He values the shares today at €11. Siemens will have a very different profitability profile in coming years. DM: RHJ has been one of the great value traps in Europe over the past few years. They’ll have to be more flexible in how they manage their manufacturing footprint and their people.K.K. Investors appear unconvinced.I N V E S T O R I N S I G H T : Looking Back. for example.75 0. Around 75% of our total Lloyds position is in its debt. and the company is clearly now headed in a new direction. Under CEO Leonhard Fischer. RHJ International (Brussels: RHJI:BB) Business: Belgian holding company with investments primarily in Japanese industrials.K.’s Lloyds [LYG]. Give an example of a company that you believe gets it.” says David Marcus. Exchange Rate: $1 = €0. RHJ stock went below €3.7 15 12 9 6 3 2009 2010 0 THE BOTTOM LINE While the company has been “one of the great value traps in Europe over the past few years.5 million €10. The companies that don’t get it are destined for oblivion. The turnaround won’t happen overnight. DM: Siemens [SI] is a good example. other publicly available information www. Nothing about the strategy worked. New direction signaled by acquisition of U. It’s a fairly risk-averse approach. If things take longer to rebound. a board member with a long track record in the financial services business at Credit Suisse and Germany’s Allianz. which appears to be in the process of a fairly dramatic transformation. but we’re finding financials with upside as they continue to come back from the brink.0% €541. but within the next 18 to 24 months we’d expect many of the Japanese holdings to be gone and the capital redeployed into what is likely to be an increasing supply of quality businesses for sale from distressed sellers. downside in the equity should be well cushioned by the yield on the debt. private bank Kleinwort Benson from Commerzbank (which was having its own problems). Management is driving what we expect to be the most significant change in the company in its 150-year history. predominantly in the autoparts business. The rest of our Lloyds position is in its equity. and expects new management to create “significant additional value over time. he believes its planned transformation into a European financial services holding company has great promise. lumbering companies of Old Europe don’t have to change. which we’re highly confident is money good. TTM): €911. It was set up as a Belgian holding company by Timothy Collins of the private equity firm Ripplewood Holdings. Which is not to say that giant. the focus is shifting completely to acquiring and growing financial-sector firms in Europe. so if things work out as we expect. but appears to be adequately capitalized and has intact earnings power that is far above what they’re making right now.81): Financials (1/31/10) Stated Book Value Book Value per share Current Share Price/Stated Book Valuation Metrics (Current Price vs. The U. May 28. They will have to have a more international outlook. 2010 Describe your investment case for RHJ International [RHJI:BB]. while those that do – as long as they are identified early enough – are likely to make nice investments. Share Information (@5/27/10. yielding 13%. The stock came out in the high-teens in 2005 and value investors flocked to it.valueinvestorinsight. which we think is appropriate today in these types of situations. Last October RHJ announced it was buying the U. thinking it was a cheap way into the “inevitable” restructuring of oldline Japanese manufacturers. and as the auto-parts business imploded.30.70 59% Price 52-Week Range Dividend Yield Market Cap RHJI PRICE HISTORY 15 12 9 6 3 0 2008 €6.” Sources: Company reports. is more than 40% owned by the British government. moving production to lowercost countries and significantly reducing headcount and costs.

Net cash on hand. post-deal. less-liquid positions in small companies was not where you wanted to be in 2008. is close to €2. is worth around €3. at current market values.com Value Investor Insight 12 . our all-cap fund that could also short and diversify more broadly across geographies held up far better. but I’m less concerned because Leonhard Fischer appears to be very capable and because they do have a solid asset upon which to build in Kleinwort Benson. less an across-the-board haircut to be conservative – are worth another €3. Looking Forward There’s a blank-check aspect to this that I don’t usually like. how are you valuing the stock? DM: We’re basically looking at what we consider a conservative sum-of-the-parts valuation today. in general. Finally. and then was up 64% in 2009. the pub- licly traded holdings are worth around €2. but I’m wary about holding too large a stake and. 2010 www. holding large. VII May 28. 75% above today’s share price. That fund was down only about half the rate of the indexes in 2008. industry sector or geography.valueinvestorinsight. That brings our intrinsic-value estimate to around €11. Given the drastic changes you expect in the portfolio holdings. Holdings in unlisted securities – at RHJ’s estimate of value.50 per share. Unfortunately. In a crisis people sell indiscriminately without regard to valuation. I expect to be paid substantially more for taking the risk. I still invest in small-caps. so the bids dried up for a lot of our portfolio. At the same time. carried at RHJ’s acquisition cost. Has the aftermath of the crisis prompted any changes in your approach? DM: One of the primary funds I managed entering the crisis was focused on small-cap European special situations. often taking an activist role to promote the change we considered necessary. If the strategy is successful. I mentioned that we put a premium on catalysts and there are many potential ones here as management more clearly articulates the new strategy and assets get bought and sold.I N V E S T O R I N S I G H T : Looking Back.50 per share. especially over a Japanese industrial. Those are today's valuations – we expect management to create significant additional value over time. and assume that the transformation will add rather than subtract value from that. we also think there’s an added shareprice kicker down the line because a financial company should ultimately earn a higher valuation from the market. As of now. There are four basic pockets of value: Kleinwort. RHJ’s shares are just really falling through the cracks. We’d take large stakes in small companies. My conclusion from that experience is that in managing your portfolios you have to retain the ability to be opportunistic and can’t box yourself in too tightly with respect to cap-size.

than have to think about things like steel-price futures curves. Kovitz Investment Group. If there's something important for us to discuss.” Value Investor Insight 13 .com Jonathan Shapiro. the more stable the business the better. Kovitz balks at certain traditional investment-firm processes. The stock price fell to where we didn’t really need to have a specific opinwww. Our analysis is centered on determining normalized earnings levels and estimating future cash flows. Johnson & Johnsons and Procter & Gambles of the world. There’s been little relative interest in the Wal-Marts. the share price and valuation getting low enough is usually all the catalyst we need. A year ago no business looked predictable. Lowe's. create a bias toward action that is a mistake.” How is that reflected in your strategy? Jonathan Shapiro: That reflects our belief that investing success is about making consistent and informed decisions based on hard evidence and sound logic rather than on hopes. of course. which is an excellent business for its industry – variable cost structure. Another example would be Lockheed Martin [LMT]. where the primary decision is whether the expectation built into the stock that it can’t really grow any more is right. We have in the past owned Nucor. from the University of Chicago. Jonathan Shapiro after nearly ten years as a KMPG healthcare consultant returned to school in 1995 to earn an M. we know where to find each other. as investors seem far more enamored with the companies hit hardest by the downturn and which have the most perceived upside leverage to an improving economy. In general. where people are supposed to bring ideas for discussion. in which we’d be willing to invest at the right price. he took a first job as sell-side analyst. which isn't my personality. JH: We in many ways are looking for the path of least resistance. though. you’ve described your focus on opportunities in which you’re “reasonably certain of a good result rather than hopeful of a great one. maybe it doesn’t really have the margin of safety you think it does. It also reflects the types of companies in which we invest. most over $1 billion in market cap. “It wasn't the greatest first step. One example: “I've always thought regular investment meetings. we didn’t have to have an opinion about future growth in steel demand because we saw value there even if steel prices stayed at depressed levels. so we stay away from industries that are more likely to be disrupted by technology product cycles or commodity-price swings. Jonathan Shapiro and Joel Hirsh of Kovitz Investment Group explain the “five-year rule” that has helped them avoid mistakes. May 28. Bank of New York Mellon and Wells Fargo are mispriced. Blue-chip companies often suffer from not having the “catalyst” so many investors want to see. and why they believe Walgreen. will we sleep well at night with it in the portfolio? We find answering that question is a great line of defense against big mistakes.B. More quantitatively. economies of scale and/or scope. “The environment was too promotional.” Shapiro in 1999 found a more comfortable home in joining the investment team of childhood friend Mitchell Kovitz at Chicago's Rothschild Investment Corp. As the share price went up.A.valueinvestorinsight. 2010 What types of things today are making such admirable companies inexpensive enough to buy? JS: A lot of the opportunities we’re finding really seem to be a function of boredom. I also found it disconcerting that the people I worked with didn't really know much about valuing individual stocks. If we hold a stock and the market closes for five years. low-cost producer. we’d rather own a Wal-Mart [WMT]. we needed to have a positive view on the future demand in order to justify owning the stock. Joel Hirsh: Top of mind for us in identifying potential investments is what we call the five-year rule.I N V E S T O R I N S I G H T : Kovitz Investment Investor Insight: Kovitz Investment Group Mitchell Kovitz. It’s one of three domestic steel mills controlling two-thirds of the market. We’ve built a database over the years of around 400 investable companies. Quoting Warren Buffett. While pursuing a traditional value-investing strategy. For us. dreams and emotions. Our feeling is that if there is a catalyst for an individual stock. At the price we found it interesting. why their most unusual investing experience still holds appeal. they have high returns on capital. They tend to be market leaders with sustainable competitive positions. After graduating. low financial risk and high correlation between earnings and cash flow. I was teaching some of them how to do discounted cash flow analysis. how they try to simplify decision-making. If you’d find yourself needing regular market feedback to be comfortable with your estimate of value.” he says. Mitchell Kovitz Meeting of Minds Intent on pursuing an investment career. high returns on capital. it’s usually well known and well priced in. The two took the team out of Rothschild in 2003 to set up their own firm. low capital requirements and competent managers who have shown decent capital-allocation skills. which we bought last quarter. but for the most part.

the stock price has been as low as $58 and as high as $418 over the past two years. 2010 Do turnarounds often meet your criteria? JS: Rarely. Jude Medical [STJ]. maybe 30% below our estimate of intrinsic value. but given today’s prices. Mitchell Kovitz: We’ve had the good fortune to build a client base that allows us to truly have a long-term perspective and that doesn’t judge our performance on a quarter-by-quarter basis. adjusted for the split. With the stock down sharply in the past three months [now around $300]. We’re more interested in playing the temporary variance from a consistent. based on the potential upside and. and after all that’s happened we still believe that’s about what the shares are worth. as importantly. We thought the worst-case cuts were priced into the shares. Walgreen and CVS. Today we’re short cyclical industrials and commodity-related stocks. Explain the long case for Walgreen [WAG]. We obviously wish we would have averaged down as the shares got so low in 2008 and early 2009.com Sardar has done some controversial things. but we were finding plenty of other things to buy that didn’t have the same type of risk. but the multiple was typically too high for us. a la Warren Buffett. Mitch. What’s the story there? JS: This has probably been our most unusual investing experience. documented record of success than relying on a wholesale turnaround or transformation into something new and improved. So we will have direct hedges and indirect hedges. JS: One thing we may do a bit differently from others is that once we’ve identified a stock as something in which we’re interested. What role does shorting play in your hedge fund? JH: We expect over time to generate the bulk of our outperformance from a concentrated long portfolio. Our initial intrinsic value estimate was in the $440 range. simply because we consider their relative prices versus the blue chips we own to be extremely high.I N V E S T O R I N S I G H T : Kovitz Investment ion on overall defense-spending levels. Describe your decision-making process for what makes it into the portfolio. Joel and I will all separately look at the valuation and arrive independently at what we think we ought to pay. Once there. if the intrinsic value hasn’t been impaired – or hasn’t been impaired as much as the stock hit implies – that can provide opportunities for us to buy. although its higher-margin non-drug sales have been Value Investor Insight 14 . Sardar Biglari was an activist investor who owned the stock at that time and he ran a proxy contest to get on the board. When we reach different conclusions. yes. so all we needed to believe to see upside was that the odds favored things turning out better than expected. There’s more uncertainty attached to large-scale turnarounds than we’d like. Each has a store base of highly convenient locations that would be next to impossible to replicate. JH: We’re generally positive on the pharmacy business. we still think the stock [at around $38] offers excellent value. reducing costs without hurting the customer experience and redirecting all growth through franchising rather than company-owned stores. Have you stood pat through all that? JS: For the most part. Your position in Biglari Holdings [BH]. We got into it in 2007 as Steak n Shake’s share price fell on what we thought were primarily economic concerns. He’s done an excellent job of getting the company on track. but believe the core value in the Steak n Shake business is very compelling. We absolutely believe the end decision is better as a result. This was a case that ended up being a turnaround. we’ve been recent buyers as the discount widened. although that wasn’t at all our expectation going in. we think you’re better off owning Procter & Gamble. that leads to a very important back-and-forth as we try to find a meeting of the minds. You can be right there will be tremendous growth in emerging markets. seems out of place. energy or mining stock. It goes back to what we said about reasonable certainty of a good result rather than hope for a great one. he saw how poorly the company was being run – particularly with respect to capital allocation – and he eventually took over in 2008 as Chairman. with two dominant players. Coca-Cola or Diageo for emerging-markets exposure than. With our eye on earnings power a few years out. We had followed the company for some time. The stock fell 15% over a few days in October when sales to hospital customers of its pacemakers and ICDs [Implantable Cardioverter Defibrillators] came in lower than expected.valueinvestorinsight. But as growth slowed – and especially with this last leg down that we considered an overreaction – the stock got to the point where we started buying from the growth investors who were selling. and we’ll opportunistically short purely to make money. a materials. one of your largest positions. that continue to take share in a business with clear economies of scale. He proposed a compensation plan that pays him like a hedge fund manager – taking 25% of book-value increases above a certain level – and created a holding company under his name to invest. May 28. Accounting for a 1:20 share split. It’s a combination healthcare business and sundry retailer. www. the potential risk. say. we’ll try to take advantage of relative value discrepancies. That’s an easier analytical challenge to take on. When our portfolio got to something like 30% in consumer discretionary stocks last year. We’re not overly excited about these extracurricular things going on. or on spending on key projects like the F-35 fighter-jet program. So when a stock gets hit because it misses a quarterly sales or earnings number. An example of that from the fourth quarter of last year is St. But we also believe hedging adds value to risk-adjusted returns over time. Walgreen has weathered the recession better than most retailers. for example. we used a laddered put spread on two related ETFs to hedge that position. formerly Steak n Shake. which we believe supports extremely attractive economics.

2% Company Vanguard Group Fidelity Mgmt & Research BlackRock Bank of NY Mellon Capital Research Short Interest (as of 5/14/10): % Owned 3. the wave people have been talking about for years of blockbuster drugs like Lipitor and Viagra going off-patent is about to hit. we’re also not convinced people are going to stop going to the pharmacist a mile away because they can now more easily get their prescriptions by mail. Overall store profitability will improve as the existing store base matures – it can take at least two years for a new store to hit its stride. which is great news for a company like Walgreen.20 to $2.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 32.64 billion $65.com Value Investor Insight 15 . which makes both higher gross dollars and margins on generics. we expect within two to three years that Walgreen can earn $3 per share. given the less-discretionary profile of the items sold. We also don’t believe top-line growth is over yet. They’re slowing newstore growth and focusing on improving the economics at existing stores through cost cutting. how are you looking at valuation? JH: As the operating leverage kicks in. With the shares recently at $32. and aren’t factoring it into our intrinsic value calculation. so fewer new stores as a percentage of the total is a positive for margins. low-double-digit annual rate.I N V E S T O R I N S I G H T : Kovitz Investment pressured. Finally.5% to 3% per year.S. other publicly available information www. We’re not finding that many businesses capable of that kind of organic growth.6 S&P 500 17. All in. the breadth of Walgreen’s store locations and its brand equity could give it a leg up.6% 1.69 1. The population is still aging and will consume more drugs.8% 2.6% 2. reducing the number of SKUs and improving inventory turns.2% 1. It’s not obvious the cost difference will be enough to change pretty ingrained consumer preference.7% $31. shouldn’t be gone forever.34 27. May 28. which has weighed on revenue and earnings growth and held the share price down. however.30 for the fiscal year ending in August.35.26 billion 5. it will certainly be the case that there won’t be enough primary-care physicians. On top of all that. Sources: Company reports. given how the story here is changing from one about store and revenue growth to one about free-cash-flow conversion. 2010 Unless insurers or employers begin to mandate it.89 – 40.700 locations selling prescription drugs. We look at this as a free option. (@3/31/10): WAG 15. If that happens. the front-end sales that were hurt by the recession. Based on both his DCF analysis and putting a reasonable multiple on that earnings power. non-prescription drugs and general merchandise in all 50 U. With a larger insured population. Joel Hirsh expects the company to increase earnings within two to three years to $3 per share. up from an estimated $2. We see several key items driving significantly improved operating margins and returns on capital.6% 3.valueinvestorinsight.2 14. We think that’s short-sighted. states. Share Information (@5/27/10): Trailing P/E Forward P/E Est.5% 2.7 13. he believes the shares’ intrinsic value today is at least $50. One potentially exciting competitive opportunity for Walgreen is to expand its in-store health clinics. What threat do you see from pharmacy benefits managers like Medco Health Solutions and Caremark (now owned by CVS) pushing their mail-order prescription businesses? JH: This is not a new risk. Based on both our DCF analysis and putting a reasonable Walgreen (NYSE: WAG) Valuation Metrics (@5/27/10): Business: Drugstore operator with nearly 7. we expect Walgreen to increase free cash flow per share at a high-singledigit. and these kinds of clinics that are staffed by nurse practitioners could expand dramatically to INVESTMENT SNAPSHOT pick up the slack. and given the secular tailwinds in the business we think PBMs could increase their mail-order share and Walgreen could still generate the free cash flow growth we expect. which will also impact drug usage.6% 50 Revenue Operating Profit Margin Net Profit Margin WAG PRICE HISTORY 50 Shares Short/Float 40 40 30 30 20 2008 2009 2010 20 THE BOTTOM LINE With continued solid growth potential and an increased emphasis on store profitability. New-store openings will probably add organic growth of another 2. Healthcare reform should significantly increase the number of insured.

hardly the norm in retail. With same-stores sales growing 1-3% per year. which had always been sub-standard relative to those at Lowe’s.2 S&P 500 17. avoiding the kinds of price wars that would hurt them both. Sources: Company reports.I N V E S T O R I N S I G H T : Kovitz Investment multiple on that $3 in earnings power.700 large-format stores in the United States. that gives them a perfectly reasonable mid-single-digit revenue growth profile. operating more than 1. The two companies have been smart about how they compete with each other.54 1.25 billion $47. including Wal-Mart. The two big market players have further consolidated the business through the downturn. we’d expect that kind of growth to be leveraged into annual bottom-line growth of 9-10%.78 billion 6. the CEO after Robert Nardelli. but the complexity of the combined CVS/Caremark makes it a somewhat riskier proposition. Frank Blake. 2010 www.3% 35 30 25 20 15 10 Revenue Operating Profit Margin Net Profit Margin LOW PRICE HISTORY 35 30 25 20 15 10 Shares Short/Float 2008 2009 2010 THE BOTTOM LINE The company has managed intelligently through the downturn in housing-related spending. Lowe’s has grown its footprint rather quickly through the downturn. and there’s likely to be a lot of pent-up demand after the past couple of years.8% Company T. Describe your specific interest in Lowe’s [LOW]. Do you expect that to continue? JS: From 2006 to 2009 the company expanded square footage by about 20%. other publicly available information May 28. While it still has a fair amount of potential to grow. improve customer service and invest in logistics systems. What about the risk to Lowe’s of Home Depot emerging as a more-focused. How do you compare Walgreen as an opportunity to CVS? JS: CVS trades at an even lower multiple today than Walgreen.8% 3.6% 1.02 – 28. Rowe Price Vanguard Group Capital Research Fidelity Mgmt & Research BlackRock Short Interest (as of 5/14/10): % Owned 4. With smart cost control and share buybacks. While we expect those things to have a positive impact on Home Depot’s profitability.com . and is poised to generate annual bottom-line growth of 9-10% without assuming a return to the heyday of a few years ago. focus the operational scope.5 17. says Jonathan Shapiro. which has supported pricing – in fact. now trading at just over $25? Value Investor Insight 16 Lowe’s (NYSE: LOW) Valuation Metrics (@5/27/10): Business: Second-largest home-improvement retailer in the world.valueinvestorinsight.7% 3.12 18. Consumers will continue to view their homes as a prized asset. We like them both. management recently announced they weren’t going to expand the store base this year and instead will focus more on the types of operational improvements we’re seeing at Walgreen. but long-term we think home-improvement retail is an excellent business.5% 3. has done the right things to slow growth. the shares would trade above $40. What upside do you see for the shares. Share Information (@5/27/10): Trailing P/E Forward P/E Est.5% $36.7 13. We also like that there are no serious competitive threats. JS: The housing downturn has obviously been a negative for companies like Lowe’s and Home Depot. Canada and Mexico. worthy of investment. INVESTMENT SNAPSHOT You are also fans of home-improvement retailers.5% 2. we come up with an intrinsic value for the shares today of at least $50. so we have a much smaller position.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 25. We’d be content if they settled into store capacity growth of 3-4% per year. rejuvenated competitor? JS: Lowe’s kind of had its way with Home Depot from 2004 to 2008 as Home Depot struggled to turn things around. we don’t expect them to change the competitive dynamic to any great extent with Lowe’s. At 16-18x his earnings estimate two to three years out. which just doesn’t have the store space to disintermediate many of the key product categories. Lowe’s gross margins went up in 2009. primarily due to integration issues stemming from its merger with Caremark and its underperformance relative to other major PBMs. (@3/31/10): LOW 20.8% 3.

At a 16x multiple. still well below the peak.65 1. The asset management side consists of Dreyfus. Our long-only accounts. and several smaller boutique managers.4%) Company Davis Selected Advisers Massachusetts Fin Serv Capital Research State Street Corp Vanguard Group Short Interest (as of 5/14/10): % Owned 6. he says.I N V E S T O R I N S I G H T : Kovitz Investment JS: In 2009 Lowe’s earned around $1. other publicly available information www. We looked historically at what Lowe’s earned on a sales-per-square-foot basis.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 28. that would translate into an intrinsic value today in the low $30s. They also have a large wealth management business catering to high-net-worth individuals and family offices. with non-interest income – mostly fees – accounting for 75% of total pre-tax income.6% 3.90 per share.1 trillion under management. But if the bottom line grows as we expect.7 13.3% $34. the increase in its stock price has outpaced Lowe’s by a meaningful margin over the past couple of years. we earlier this year reallocated all our capital invested in Home Depot to Lowe’s. As a check. which is a wholly owned subsidiary. We analyzed a variety of scenarios for normalized earnings and arrived at a base-case range of $250-275 in sales per square foot and operating margins of 9%. They earned almost $2 per share in 2007. If you put a 16-18x multiple on our range of normalized earnings.85 billion (-14.com Value Investor Insight 17 . Why do you find it attractive? JH: The company in its current form came out of the 2007 merger of Bank of New York and Mellon Financial. they do things like hold institutional assets.9% 4. How are you looking at the downside? JS: It’s hard for us to imagine normalized earnings of less than $1. Because of that and the fact we believe Lowe’s normalized earnings have more room to grow from their current depressed levels.80 – 32.8% 3. the stock would trade for at least $45.1 S&P 500 17. that would give you a share price of $22.20 per share. we see the upside by then of $40 to $45 per share. which has a huge money-market-fund business. (@3/31/10): BK n/a 12.75 to $1. are held at Pershing. Share Information (@5/27/10): Trailing P/E Forward P/E Est.4% 50 Revenue Operating Profit Margin Net Profit Margin BK PRICE HISTORY 50 Shares Short/Float 40 40 30 30 20 20 10 2008 2009 2010 10 THE BOTTOM LINE The market is treating the company as if it were a traditional bank and not one as focused as it is on fee-generating businesses in which it typically has a leading market position. Bank of New York Mellon [BK] stock has gone nowhere over the past year.valueinvestorinsight.50. Using the same multiples. Do you have a favorite between Lowe’s and Home Depot? JS: While we still view Home Depot favorably. for examINVESTMENT SNAPSHOT ple.40 per share. earnings in a few years would be closer to $2. During the boom years.00 billion $7.50.5%) (-11. Operating margins peaked at 11% in 2007. broken down further by average ticket sizes and the number of transactions.4% 1. which is around what the company is expected to earn this year. Sources: Company reports.03 25. creating a formidable global player primarily in the areas of asset custody. At a more reasonable multiple of normalized earnings power he estimates at around $3 per share. securities servicing and asset management. says Joel Hirsh. The business mix is different than a traditional bank’s. average ticket sizes within this range would be $55-60. execute trades and otherwise handle money flowing in and out. May 28. 2010 Having weathered the downturn better than most financials. On the back-office side. We also like the competitive environment: Scale matters a great deal in most of their markets and they – along with State Street or Northern Trust – are often one of only Bank of New York Mellon (NYSE: BK) Valuation Metrics (@5/27/10): Business: Provider of asset management and securities-related services with $22 trillion in assets under custody or administration and $1. sales per square foot hit $320 and average ticket sizes were about $65. which we believe was truly a trough level for them. which would translate into earnings from the existing store base of $1.1% 4. which is only 11% below where the stock trades today. which we don’t believe was normal either.

that should translate directly into a higher multiple.41 21.2 S&P 500 17. So is this more of a multiple-expansion than earnings-rebound story? JH: It’s both.com Value Investor Insight 18 . assets under management continue to modestly recover and that money-fund fees – which are being waived with interest rates so low – go back to normal. investment and mortgage financial services. we don’t think this will continue to trade like it’s just another bank.30 per share this year.57 – 34. from today’s price [of $28] that kind of potential upside certainly is. The financial-market disruption of the past few years has resulted in Wells improving its competitive position as many competitors have been forced to retrench. you Wells Fargo (NYSE: WFC) Valuation Metrics (@5/27/10): Business: Diversified U. as the credit-quality situation stabilizes. MK: Our thesis here is more big-picture than the detail we spoke about for Walgreen or Lowe’s. As the market gets comfortable that the credit issues were an aberration.7% Company Berkshire Hathaway Fidelity Mgmt & Research Wells Fargo Vanguard Group Capital World Inv Short Interest (as of 5/14/10): % Owned 6. That doesn’t require heroic assumptions.9% 3. JH: When you talk about normalized earnings for financial institutions. We assume Wells has raised all the equity it will need in order to weather ongoing loan writedowns. By executing well. Fee-driven asset managers and servicers have historically traded for 1520x earnings.25 0.9% from 2003 to 2008 – that are the envy of the industry. Overall. sell out or shut down. Lend May 28. That translates into better pricing power and margins. The benefits of that have shown up in its ability to increase deposits.2 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 29. says Mitchell Kovitz. Sources: Company reports. While the story and the company may not be particularly exciting. Total assets: $1. independent of the huge addition to assets from buying Wachovia in late 2008. So with a better multiple on higher earnings. As for the multiple.3% 3. earning INVESTMENT SNAPSHOT assets on which Wells earns a spread have gone up 115% from pre-Wachovia times. but it seems to have caught the market by surprise and would explain the rather sharp multiple contraction.3% in the first quarter of 2010. while the equity issuance from the acquisition and additional capital raises have resulted in dilution of less than 60%. Put some numbers on that. we’re looking for a share price in the $45-55 range over the next couple of years. (@3/31/10): WFC 17.7 15. the stock would be worth $50-60 per share. Attract and retain low-cost deposits by focusing on customer service and building deep and broad relationships with clients. we expect earnings power for the overall company to increase sharply. At 10-12x the $5 per share he believes Wells can earn within three years. Wells’ basic strategy is relatively simple.39 billion 32. What appears to be weighing on the stock is the fact that the company ended up with more bad assets than expected – mostly real estate related – as the credit bubble burst.7% $153. insurance.5% 17.1% 4. Earnings are expected to come in at around $2. Share Information (@5/27/10): Trailing P/E Forward P/E Est.23 billion $66.3% 40 35 30 25 20 15 10 Revenue Operating Profit Margin Net Profit Margin WFC PRICE HISTORY 40 35 30 25 20 15 10 5 2008 Shares Short/Float 2009 2010 5 THE BOTTOM LINE The company’s industry-leading ability to generate earning assets and high net interest margins should result in sharply higher earnings as loan-loss provisions eventually return to normal. We’d argue that the damage has been and will remain relatively light. which is perfectly reasonable for a company with Bank of New York’s business mix and scale. describe the potential you see in Wells Fargo [WFC]. down from an average of 4.7 13. Turning to a more traditional bank.1% 1. not chasing the latest fad or going far afield to put assets on the books. 2010 prudently and traditionally.I N V E S T O R I N S I G H T : Kovitz Investment two major competitors. just that the excess loanloss provisioning goes away.valueinvestorinsight. Wells earns net interest margins – 4. provider of consumer and commercial banking. but we believe the normalized level is closer to $3.2 trillion.6% 3. other publicly available information www. As a result.S.

but you just can’t let that distract you from your discipline and your framework. trading at 40 to 60 cents on the dollar. translating into a share price of $5060 per share. VII What are the world’s best investors buying and selling? Gain insight from what superstar investors own. Things like our five-year rule. We’ve said this since we started out: The market is really just a pendulum that forever swings between unsustainable optimism. sell to the optimists. we believe the stock is worth roughly $40 today. Any themes of interest in that area? MK: One fairly surprising opportunity we’ve found is in certain Alt-A Collaterized Mortgage Obligations (CMOs). what they’re buying and what they’re selling.I N V E S T O R I N S I G H T : Kovitz Investment also need to have a normalized provision for loan losses. which makes stocks too expensive. somewhat. If Wells earns near the $5-per-share level we expect within two to three years. are even more important in a market like today’s.com Value Investor Insight 19 . if the economic recovery is much slower or Wells has to raise equity capital and we’re wrong by even 50% on earnings power. You manage a significant amount of fixed-income assets. All we’re trying to do is keep a level head. we’d still make the argument that its franchise and competitive position warrant the same multiple. which makes them too cheap. Any parting advice to investors grappling with an increasingly scary time in the market? JS: The market is extremely noisy. now around $29.50? MK: Based on our estimate of current normalized earnings and a conservative 10x multiple. 2010 – DON’T MISS IT! Subscribe Online » Mail-in Form » Fax-in Form » Or call toll-free: 866-988-9060 Want to learn more? Please visit www.valueinvestorinsight. for example.30 per share.com May 28. Is that growth basically a function of an economic recovery working its way through the financials? JH: Yes. we see no reason that wouldn't deserve a 10-12x multiple. and buy from the pessimists. we wouldn’t expect much worse than that. but we think it’s an intriguing opportunity. Value Investor Insight subscribers receive four quarterly issues of SuperInvestor Insight for only $149! NEW ISSUE to be published on June 1. With respect to downside. So while we may be sitting on dead money if that were to happen. that number should be closer to $5. Assuming loan losses return to their historical average – stripping out the too-light provision years of the credit bubble and the massive provisions of the credit debacle – we believe normalized earnings on Wells’ current asset base is $4 to $4. If you’re right on earnings power. We’ve modeled extremely high assumptions for defaults and severities and low ones for prepayments and still expect to get 12%-plus annual returns. 2010 www.valueinvestorinsight. By 2012. We're assuming Wells' competitive position will allow for continued growth in its asset base along with growth in non-interest income from a depressed level. and unjustified pessimism. what’s a reasonable expectation for the share price. That’s certainly not the bulk of what we own.

The company's basic strategy is fairly straightforward. He expects the best 900.7 13. Assuming long-term natural gas prices of $7. against today's price of around $4. cleaner and more politically palatable than many of its competitors. An opportunity for contrarian investors? Not across the board. Cash flow from its Barnett Shale and Nora Field properties – both highly productive and efficient. his current fair value for the company’s shares is $78. He does believe over time that a strong demand case – mitigating the dramatic increase in supply – can be made for natural gas. 2010 cases below $3 per Mcf – is being reinvested in the development of Range's Marcellus Shale properties in the Appalachian Basin.8% 11. Morningstar calculates the “fair values” of such stocks using discounted-cash-flow models that assume long-term gas prices of $7.com Value Investor Insight 20 . says Eric Chenoweth. (@3/31/10): RRC n/a 55. coupled with improved technology to extract them more efficiently. The question for investors: Does any of that translate today into investment opportunity? For those prospecting for ideas in beaten-up sectors. “Everybody knows” massive discoveries of gas reserves in the U. remain at historic lows. and is plentiful in the U.5 million 10.50 per thousand cubic feet [Mcf]. “We’ve seen sector-wide value opportunities in natural gas at times over the past five years.7% 80 70 60 50 40 30 20 Revenue Operating Profit Margin Net Profit Margin RRC PRICE HISTORY 80 70 60 50 40 30 20 2008 THE BOTTOM LINE Shares Short/Float 2009 2010 The market isn’t recognizing the extent of the high-return development potential of the company’s Marcellus Shale properties. says Morningstar energy analyst Eric Chenoweth.000 acres of its Marcellus properties to produce excellent returns well into the future. says Chenoweth. 30% below what India's Reliance Industries recently agreed to pay to partner with Atlas Energy in developing Marcellus properties – Chenoweth says the share value is closer to $90. most gas stocks are fully valued today. development and acquisition of natural gas.0%) Largest Institutional Owners Company Fidelity Mgmt & Research T.” says Chenoweth. even if gas prices are as low as $4 per Mcf.5 S&P 500 17.1 trillion cubic feet equivalent of reserves. Share Information (@5/27/10): Valuation Metrics (@5/27/10): Trailing P/E Forward P/E Est. he says. located primarily in Texas and the Appalachian Basin. and elsewhere. which over long periods of time have tracked oil prices.13 0.50/Mcf.S. But Chenoweth argues that rising prices from long-term demand shifts are already baked into most current gas-company equity prices. INVESTMENT SNAPSHOT Range's virtuous reinvestment cycle appears lost on the market. will weigh on prices into the future. Morningstar finds particular upside in Range Resources [RRC]. The company was an early mover in Marcellus..4% $7.48 – 60. so it benefits from favorable lease terms and from having acquired extremely high-potential properties. Based on an alternative sum-of-the-parts analysis – using a $10. the shares trade at a 42% discount to Morningstar's $78 fair value. VII Range Resources (NYSE: RRC) Business: Exploration. At just under $45.000-per-acre value for the Marcellus acreage.2 Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 44. “Now isn't one of those times.3% 7.7% (-1. lessening dependence on foreign energy sources and making it likely to be more politically favored. Using that assumption.U N C O V E R I N G V A L U E : Range Resources It's a Gas Natural gas as an energy source is cheaper. a Texas-based natural gas producer with a reported 3. gives off half the carbon dioxide of coal in power generation.S.17 billion $876.” Which is not to say specific opportunities don't exist. the natural gas business would appear to be a candidate for review.6% 6. other publicly available information www.valueinvestorinsight. with production costs in many May 28. It's relatively cheap. Rowe Price Neuberger Berman Short Interest (As of 5/14/10): % Owned 8.25. Sources: Company reports. Gas prices on an energy-equivalence basis.95 35.

2010 May 28.13 61.7x for the S&P 500.51 31.11 30. Buffet's largest bet? Coca-Cola has been Berkshire's top position since the fourth quarter of 2008.94 5. Pershing Square and Edward Lampert's ESL Investments) each had more than 30% of their reported holdings in their top stock. but it has been some time since the shares of the soft-drink giant have captured the market's fancy.07 22. 2010 www. but have pulled back sharply as concerns about the continued strength of U. We believe that a policy of portfolio concentration may well decrease risk if it raises.valueinvestorinsight.S. 17% of the dollar value of each portfolio's reported equity holdings.50 53.00 13. The smallest holding: Pzena Investment's 4% portfolio position in Northrop Grumman.42 37.35 88. JPMorgan Chase was the only bank earning top-holding status – with three different SuperInvestors. and SLM. Owens-Illinois is a low-cost producer and operates as a regional monopoly in many of its markets. We disagree.36 55.24 9. three top holdings have current market values of less than $5 billion: glass-bottle manufacturer Owens-Illinois.90 36.20 42.11 26.55 40. Warren Buffett offered one of the many arguments he's made over the years for portfolio concentration: “The strategy we've adopted precludes our following standard diversification dogma.96 57. vs.com .83 39.92 55. Three investors (Icahn. JPMorgan Chase. and Valeant Pharmaceuticals.60 12.71 18.42 40.75 33.70 118.52 Investor Berkshire Lampert Paulson Icahn Pershing Square Viking Relational Lone Pine Highfields ValueAct Pzena Blue Ridge Greenlight Glenview Eminence Baupost Omega Pennant Atlantic Brave Warrior Sources: Forms 13F filed with the Securities and Exchange Commission for holdings as of March 31. larger investments than a broad array of small ones.03 40. as it should. but its shares – like those of most big banks – remain highly leveraged to economic recovery. At a recent $51. Only one stock. While large-caps dominate the list. In his 1993 letter to Berkshire Hathaway shareholders.23 88. by Greenlight Capital.67 25.63 17. The 20 biggest top SuperInvestor holdings (see table) as of March 31 accounted for.59 24.69 34. 17.31 73.46 52-Week Low High 46. which markets neurology and dermatology drugs.83 7. Smallest discount from its 52-week high: McKesson and SPDR Gold Trust.94 71. was the top holding of multiple investors.03 48.06 42.40 69.82 5.56 19. aircraftcomponent maker TransDigm. by Omega Advisors.20.36 58.24 70. but its shares have taken a sharp hit lately due to its revenue and profit exposure to Europe.49 11. consumer spending – to which its fortunes are intimately tied – have increased. VII The new SuperInvestor Insight appears June 1.42 59. The company has been credited with navigating the financial crisis more ably than most.00 22. Other battered financials receiving top billing: CIT Group.52 97. Motorola and Visa.27 31. At a recent $88. The company's shares more than tripled between the end of 2008 and April of this year.U N C O V E R I N G V A L U E : SuperInvestors Concentrated Effort Superior investors are often more comfortable making fewer. Largest discount: Sears.45 58.58 13.10.” A review of the largest investments made by the superstar investors tracked by SuperInvestor Insight would indicate fairly broad accord with Buffett's thinking.45 125.69 6. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. here are the very biggest bets being made by the industry's elite. they trade at 16. on average.19 37. VII subscribers pay only $149 – subscribe now at www. Company Coca-Cola Sears SPDR Gold Trust Motorola Target Visa Home Depot JPMorgan Chase JPMorgan Chase Valeant Northrop Grumman JPMorgan Chase CIT Group McKesson Oracle News Corp SLM TransDigm Owens-Illinois Comcast Ticker KO SHLD GLD MOT TGT V HD JPM JPM VRX NOC JPM CIT MCK ORCL NWSA SLM TDG OI CMCSK Price@ 5/27/10 51. Based on their most recent filings with the SEC.superinvestorinsight. retailer Sears is the top position currently trading at the biggest discount to its 52-week high.com! Value Investor Insight 21 Biggest Bets of the Best These are the 20 largest single holdings of individual SuperInvestors at the end of the first quarter.47 17.20 50. And what of Mr. both the intensity with which an investor thinks about a business and the comfortlevel he must feel with its economic characteristics before buying into it.31 39.42 122.42 46.7x trailing 12-month earnings.80 48.59 31.20 48.59 22.

valueinvestorinsight. 'When the going gets tough. mechanical or electronic. the tough get going. and he has since made a career out of identifying opportunities and risks largely informed by a nuanced analysis of the numbers. The U. “The 2007 letter [Paliwal's first] presented a blueprint for improving performance through cost control. In 1971 he launched (with Ted O'Glove) the Quality of Earnings Report. He argues a careful reading of today's letters is particularly important given the tumult of recent years: “The adage. 2010 » » » Or call toll-free: 866-988-9060 Want to learn more? Please visit www. without the prior written permission of VIM is strictly prohibited. two. or signal a potential buying opportunity in a company our research team has been following and monitoring for some time.valueinvestorinsight. See a summary of key terms on the following page of this newsletter.” VII John Heins Co-Editor-in-Chief Whitney Tilson Co-Editor-in-Chief Always on the lookout for better investment ideas? Subscribe now and receive a full year of Value Investor Insight – including weekly e-mail bonus content and access to all back issues – for only $349.S. John Heins. “The 2006 letter devoted two paragraphs to explaining an image of a surfer on the cover.com. Olstein lays out some of the key questions to which he's looking for answers today and why: Does management adequately discuss the company's financial strength. All rights reserved. an early forensic-accounting bible. or three years ago? The degree to which a company acknowledges the challenges posed by the recent recession and discusses its response to those challenges not only reveals a great deal about management's capabilities and credibility. Suite 400. VA 22182. risk management and simplifying business processes.valueinvestorinsight.' has never been truer than during the past three years. please visit www. it also highlights those management decisions or shifts in strategy that are likely to affect the company's future cash flow.EDITORS’ LETTER Down to the Letter Few investors are as adept in deciphering corporate financial statements as Olstein & Associates' Bob Olstein. prompt a reassessment of our investment thesis for an existing holding. working capital needs and Value Investor Insight™ is published monthly at www. transmission.valueinvestorinsight. So it came as a surprise when he mentioned in our interview with him for this month's issue that he often finds much of interest in a more prosaic section of the annual report. What management is. That’s less than $30 per month! Subscribe Online Mail-in Form Fax-in Form Subscribers may download Site content to their computer and store and print Site materials for their individual use only.com. All Site content is protected by U. Any other reproduction. Terms of Use: Use of this newsletter and its content is governed by the Site Terms of Use described in detail at www. 7) as an example for which a change in the tone and content of the company’s letters helped reinforce that new CEO Dinesh Paliwal was transforming the company for the better. Inc. Chairman and Co-Editor-in-Chief. cost controls? Does the discussion signal ongoing or growing problems with cash flow.valueinvestorinsight. and international copyright laws and is the property of VIM and any third-party providers of such content. 2071 Chain Bridge Road.000 for each act of willful infringement of a copyright. Olstein uses Harman International (see p.com www. These subtle shifts may generate investment ideas for further research. The change was striking and merited further analysis and investigation. telephone: 703-288-9060 May 28. and ultimately. has the company continued to invest in or pulled back from initiatives that will improve its competitive position or operations during the economic recovery? Do measures undertaken during the past year reveal a significant break from the company's strategy from one. cost controls. Contact Information: For all customer service. debt levels. Annual subscription price: $349. the company's financial strength? How does management discuss challenges to operations posed by the recession? Has it reacted to the changing conditions? Has the company favored across-the-board cost cutting that may put it at a strategic disadvantage during the economic recovery? In the face of recession. Vienna.com (the “Site”). cash flow. subscription or other inquiries. President and Co-Editor-in-Chief. the shareholder letter. by Value Investor Media.” In his latest investor letter. or contact us at Value Investor Insight. Whitney Tilson. and isn't. Inc. ©2010 by Value Investor Media.com Value Investor Insight 22 .” he says. display or editing of the Content by any means. and only two sentences on the failed four-month tenure of a replacement CEO. talking about in difficult times can provide a great deal of insight into its ability to create value in the future.S. Copyright Act imposes liability of up to $150.

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