Cost of "Free" Choice

This Goldman Sachs graph illustrates the explosive growth of movement from Defined Benefit plans to Defined Contribution plans.

In my first post (IBM Freezes Pension Plan), I commented that employees have never understood the tremendous benefits that Defined Benefit plans provide. Just as a teenager underestimates the benefits of living at home, so too do employees underestimate their Defined Benefit plan. I would guess it to be a factor of three.

And just as parents are financially relieved to see these freedom-seeking teenagers go off on their own, so too are companies financially relieved to see employees get control of their money by moving from Defined Benefit plans to 401(k) Defined Contribution plans.

This movement illustrates a powerful force not accounted for in economic theories describing "rational" participants. "Freedom" is a powerful elixir. Individuals would rather control their own outcome to suit their own desires than take a prescribed outcome with generally higher benefits. Recently, Alan Greenspan himself had to intercede as Americans were clamoring to use their own retirement plans rather than the benefits of the Social Security system.

Another fascinating chapter in the story of this principle is about to shape the healthcare world as participants move towards the Consumer-Directed Health Plan approach.

Glenn Greenberg

Near the top of my list of cochamim is investor Glenn Greenberg who is a partner at Chieftain Capital. In reviewing their latest 13F filing (which for the uninitiated is an SEC filing that lists the investment holdings), I sat in amazement at their willingness to put nearly 40% of client funds in one stock - Comcast (CMCSK). I created this graphic analysis of their accumulation of CMCSK.

Studying their decisions reveals a few important truths. First, Chieftain invests heavily in what they understand and can value. Starting in the second quarter of 2002, Chieftain invested about 15% of their funds in CMCSK (after a significant decline). Investment managers typically consider 2% a significant commitment.

Second, Chieftain invests and reinvests for the long term. Chieftain moved this concentration consistently over the next five years from 15% to nearly 40% as the stock price rose. Most investment managers are reducing their positions as the stock price rises and do so over much shorter time horizons.

Third, Chieftain is willing to abandon a position because of management direction. The first time Chieftain reduced their CMCSK was in response to CMCSK's attempt to purchase Disney. Despite a dropping stock price, Chieftain was willing to sell in order to express its disagreement.

Fourth, Chieftain is willing to engage in short term buying and selling. In response to a rapid rise in price, CMCSK took some gains only to return quickly and repurchase those shares. An advantage of such sizeable positions seems to be that short term buying and selling can enhance returns without forcing abdication of the stock.

Aflac: Something to Quack About

Aflac (AFL) is based in Columbus, Georgia and has a wonderful story, for its investors especially. Kenneth Janke, head of investor relations for AFL, reports "Investors who purchased 100 shares in 1955 when Aflac was founded paid $1,110. As a result of 28 stock dividends or splits, those 100 shares had grown to 187,980 shares valued at $9.6 million at the end of April 2007. In addition, those early investors would receive approximately $150,300 in cash dividends in 2007."

FinanceSpeak

So many terms in finance are deceptive that I am not surprised to hear general distrust of the industry. Sometimes I have to reread a paragraph several times to understand the negatives I am actually being presented. I wanted to establish a post to with examples.

The first and most deceptive one is "strengthening reserves." When one reads this phrase in an annual report, it sounds like something good is happening, while it should read "poorly estimated losses and now taking a bath in them." In reading for the reverse, the reports never state "weakening reserves," rather they say "releasing reserves." The proper way, then, to be truthful and clear might be to say "taking reserves," rather than "strengthening reserves."

Three Basket Choice

When I was with a good friend who is also an astute businessman, I posed the following question. Which basket would you choose? In basket #1 is an asset worth $100,000 without any debt; in basket #2 is an asset worth $100,000 as a result of $200,000 of asset value and $100,000 of liability value; in basket #3 is an asset worth $100,000 as a result of $1,000,000 of asset value and $900,000 of liability value.

He told me that he would want the basket against which he could borrow the greatest amount of money. I found this answer fascinating, because it implies that he is most comfortable where the lender has the lowest perceived risk. Because debt is a four letter word in my world, I would have chosen the basket without any debt. I am most comfortable where the equity holder has the lowest perceived risk.

An implied advantage of his way of looking at the world is that the cost of capital is much lower. When studying an asset tied-up from a loss of lending perspective, the cost of capital is roughly 8%, whereas when studying an asset tied-up from a loss of investing perspective, the cost of capital is roughly 12-15%.

Coming to Senses

The Bancrofts, the controlling family of the Dow Jones company, seem to be coming to their senses with the announcement that they will look for a potential acquirer. I have often blogged about the investment merits, or lack of, in newspapers. The declining prices have been an incentive for me to evaluate the potential opportunity.

But the words of Warren Buffett in the 2006 BRK annual report are ominous on the topic of newspapers: "...are constantly losing ground in the battle for eyeballs...faces unrelenting pressures that will cause profit margins to slide...economic potential of newspaper internet site a small fraction of that existing in the past for a print newspaper facing no competition...no rule that a newspaper's revenues can't fall below its expenses and that losses can't mushroom...fixed costs are high...lush days of profits..are over."

His admonitions have certainly affected investment thinking in this area. Not only his investment history, buy also his ownership of the Buffalo News and his shares in the Washington Post certainly make him worth paying attention to. Instead of bashing Murdoch's style, the Bancrofts might utilize their own - by writing Rupert Murdoch a thank-you note.