Bridge Street Journal, Vol. 3.14: Which Financials Will Profit?
In response to yesterday's Bridge Street Journal about various financial companies taking big hits due to not heeding the investing advice found in the scriptures, George asked which financials appropriately prepared for the current lending problems. He noted that it appears that Goldman Sachs and Berkshire Hathaway did and asked which others I thought may have as well.
First, with respect to Berkshire and Goldman: Berkshire always prepares and Goldman was certainly prepared, but it's useful to note how the two are different. Goldman, a trading firm, prepared by shorting the very instruments others were buying (and, as I understand it, that Goldman was helping others buy (don't read any sleaziness into that - you can't blame the shopkeeper for selling you cigarettes)). In fact, a few weeks back, when Goldman's price had fallen along with other financials, it reminded investors that it was short the imploding instruments (I seem to recall its price going up quite a bit that day, although the only change was that it had reminded "investors" of information it had made public long before - so much for the Efficient Market Hypothesis). Now Goldman is able to redeploy its cash to productive ends while its competitors desperately try to raise billions in capital (in order to cover severance packages for departing, incompetent CEOs, no doubt).
Berkshire was likely not short, but didn't get caught up in the nonsense in the first place (I seriously doubt Warren Buffett bought any CDOs or had any of Berkshire's money holed away in any in SIVs). Also, now that the shaky financial structures have come crashing down around others, Berkshire is in a position to step in and profit from the fallout. Not having thrown its money into the CDO black hole, BRK can now deploy its capital to buy quality assets on the cheap. You may recall a couple of years back, in the wake of Katrina, that BRK did just this: as its undercapitalized competitors went out of business due to mounting insurance claims and fear of claims, BRK bought the policies on the cheap, paid the losses, and is now making a fortune.
So, on to George's question about other smart companies. While I haven't seen much evidence of any companies being gutsy enough to go short (a la Goldman), some of the banks seem to have at least controlled their downside. U.S. Bancorp, for instance (of which Buffett owns about $65.5M shares), has a history of fiscal conservativism and does not seem as exposed as other banks. Its price, however, has suffered alongside other banks (it was below $30/ shr at one point, putting the yield over 5.3%), which might make for a sound investment if you already liked it (the last time you could buy it for this price was two years ago, and the dividend has increased each year since then).
Another interesting possibility is the title insurers, such as Fidelity National. There are only a few major players in this industry (it is one of the few truly oligopolistic industries out there). Note that title insurers are different from the mortgage insurers (like Radian) and have been hurt twofold: they are financial companies that insure housing-related things (i.e. a house's title). Every state except Iowa (in which title insurance is illegal) requires property owners to have title insurance, and it is a strange and profitable type of insurance (insuring that a property title is free of past problems instead of insuring against future events like normal insurance). In addition, most of the title insurers sport nice dividend yields, particularly in light of the recent fall-off in price. From what I have seen, there does not seem to be much exposure to the Citigroupesque foolishness of stupid investments; rather, the fear seems to be from the derivation of earnings from housing activities. This may be a worthwhile industry to consider.
Finally, some valuable assets may be found within the non-title insurers. Various insurers like White Mountain, Allegheny, and Markel have solid and increasingly profitable businesses in the face of stagnant or decreasing prices. that, combined with steadily increasing dividends (not so much in the companies mentioned, but in many of the other insurers) may make for good deals in certain insurance companies. Of course, the ultimate insurer is BRK itself, but that particular company has not been hit by the subprime issues as much as others, and a discussion of its value would not be responsive to George's question.
As a postscript, I would also add that I can't imagine putting any money into Goldman itself, despite the fact that it appears to have an uncanny ability to make vast profits regardless of the operating environment. It is a trading firm, and is inherently a black box. I don't know how, nor do I know anyone who knows how, to begin to value such a firm. While it may be a very valuable asset, I don't know how to prove that to myself, let alone anyone else. I cannot say with any certainty that Goldman is worth closer to $2,000 per share than $20 per share. Because of its inherent unpredictability, any money invested in Goldman is understood to be merely a speculation on Goldman's traders' ability to speculate. It's a perfectly legitimate thing to do - just understand what you're doing.