Continuing Warren's theme of "confessions in the Bore Port," I'd like to discuss one of my recent sales, Freddie Mac (NYSE: FRE), which was one of my worst investments. My original purchase in August 1998 at $43.69 per share did quite well for a while, but my larger purchases last year at prices ranging from $58.00 to $63.88 (average cost of $61.02 per share) did not fare so well.
In December, I sold all of it for tax-loss purposes at $48.31 per share, a 21% loss. I then waited the necessary 30 days and, believing it remained significantly undervalued, repurchased most of what I'd sold, paying $47.50 per share.
But, as my thinking changed over time (discussed below), I finally decided to sell it all in early June at $44.75 per share, an additional 6% loss. My only consolation is that the stock has barely budged, closing yesterday at $43 5/8, down another 2.5% since I sold. (I suppose I can also take consolation from the fact that Freddie Mac wasn't a very large position in my portfolio and I feel quite blessed to have only lost 25% on one of my worst investments.)
Why I Bought Freddie Mac
Freddie Mac purchases and securitizes residential mortgages, and purchases mortgage assets for its own portfolio. It was created by an act of Congress in 1970 and, though the U.S. government does not explicitly back its debt, it enjoys a favorable "government agency" status that allows it to access capital at a very favorable rate. Freddie Mac and its somewhat larger sibling, Fannie Mae (NYSE: FNM), form an extraordinarily profitable and dominant oligopoly that essentially has a government license to print money (for now anyway). It should come as no surprise that Berkshire Hathaway (NYSE: BRK.A) owns 9.3% of Freddie Mac, and that Warren Buffett cites not buying Fannie Mae as one of his worst investment mistakes.
As of the end of 1999, Freddie Mac had earned at least a 20% return on equity for 18 consecutive years, and had compounded its earnings at an annual rate of 17% for the previous 10 years -- a time during which its stock compounded at 26% annually (vs. 18% for the S&P 500 Index). Freddie Mac represents a rare combination of strong competitive advantages, robust steady growth, high returns on equity, and a P/E ratio approximately half that of the S&P 500.
Yet, Freddie Mac fell 26% in 1999, and is down another 7.3% this year due to a number of political threats as well as concerns that rising interest rates will dampen growth. Regarding the latter, there was never any question that growth would slow, given that EPS growth averaged 25% in 1998 and 1999. (In fact, EPS growth was 17% and 12% in the first two quarters of this year.) But, Freddie Mac has demonstrated an ability to grow strongly, even in the face of unfavorable interest rates, due to sophisticated hedging and risk management, in addition to ongoing market-share growth. My miscalculation was underestimating the political threats. I made a similar mistake with Microsoft (Nasdaq: MSFT) -- you think I'd learn.
Why I Sold Freddie Mac
I sold my Freddie Mac stock for three reasons:
- Freddie Mac's government license to print money is in jeopardy. Without going into the highly complex underlying economic and political dynamics, an increasing number of politicians -- and Alan Greenspan himself -- have called for significantly curtailing Fannie Mae and Freddie Mac's special privileges that underlie much of their profitability. This has introduced a great deal of political uncertainty, which I am not as comfortable evaluating as economic uncertainty.
- Freddie Mac holdings account for nearly 50% of the value of Wesco Financial Corporation (AMEX: WSC), a stock I already own. With Wesco now trading at an even greater discount to intrinsic value than the 16% discount at the end of 1999 (I estimate more than 20%), I feel even more strongly that it is a superior way to own the underlying stocks, especially Freddie Mac. (Wesco, which is 80.1% owned by Berkshire Hathaway, also holds significant stakes in Coca-Cola (NYSE: KO) and Gillette (NYSE: G). To learn more about Wesco, see my report from Wesco's annual meeting.)
- Charlie Munger, Wesco's chairman (and Berkshire Hathaway's vice chairman), sold 46% of Wesco's Freddie Mac position in the first two quarters of this year. (I suspect that Warren Buffett also participated in this decision.) Given Munger's deep experience over many decades with Freddie Mac and its industry, and the fact that he had never sold Freddie Mac stock (going back as far as 1993, at least), his sale earlier this year was telling.
Ross Stores vs. TJX
Colin Walters (known on the boards as playerofgames), a Bore Port regular, posted an interesting comparison of Ross Stores (Nasdaq: ROST) and its larger competitor, TJX Companies (NYSE: TJX). After analyzing many factors, including return on assets, equity and invested capital, inventory turns, flow ratio, topline and bottom-line growth, margins, cash conversion cycle, and valuation, he concluded that TJX was the better buy -- and bought the stock. It's an excellent analysis and I encourage you to read it (as well as my reply).
-- Whitney Tilson
Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at [email protected]. To read his previous guest columns in the Boring Port and other writings, click here.
