Trading at $25.21 as of June 7, 2002
Legg Mason Value Trust Manager Bill Miller recently spoke at a security analysis course at Columbia Business School. Michael Mauboussin, who teaches the class, noted with some glee that Bill Miller told the class a quote that captured everything one needs to know about investing.
This, as you can imagine, piqued the interest of the class. Who could the sage source of this quote be? Sir John Templeton? Warren Buffett? Keynes? Carrot Top?
None of the above. It was Puggy Pearson, a world-famous gambler who had been born in abject poverty in Tennessee, was blessed with an eighth-grade education, and a whole heap of horse sense. Puggy Pearson boiled his gambling success down to this:
"Ain't only three things to gambling: knowing the 60-40 end of the proposition, money management, and knowing yourself. Even a donkey knows that."
First off, I'd like to know where I can find a talking donkey. But second, though I can't really put this as colorfully as Puggy, I'd have to say that he's got it nailed. Be disciplined. Don't worry so much about having your choices go bad on you. Do worry about whether you are making bad choices. We're not going to bat 1.000. In investing, you don't have to.
In corporate management, it should work the same way. We've seen so many companies try to promise the world, stocks bid up to the sun, and actions so badly on the wrong side of the 60-40 proposition. And even if they may have worked out, they still could not be characterized as "smart." Keeping a 16 instead of splitting 8s -- the correct move may not save you, but it will still turn out to be correct.
Let's talk about a company that has this simple concept down pat. It's a publicly traded private finance company called Allied Capital
Allied provides equity to companies in illiquid situations so they can factor receivables, restructure balance sheets, fund expansion, or to finance a merger or acquisition. Additionally, Allied Capital holds about 25% of its funds in commercial mortgage-backed securities, which it seeks to buy well below face value. In exchange for its money, Allied Capital takes notes that average about 14% interest, an occasional equity kicker (adding a few more basis points to overall returns), and it will generally demand oversight over the recipient company's board of directors. Almost all of Allied's loans are fixed rate.
Allied Capital deals in some fairly risky situations, but it does so in situations where it has a level of compensation that balances out the higher risk. The company does not expect perfection. In fact, there has been some controversy surrounding its carrying value of an impaired loan made to Velocidata, which led to questions about the company's valuing techniques for less-transparent holdings. According to the company, they rate their portfolio components from 1 to 5, with 1 being for companies in which a capital gain is expected, 2 for ones performing as expected, on down to 5 where a loss of principal is expected. At present, more than 90% of Allied Capital's portfolio is rated 1 or 2. The recent controversy surrounding Allied's carrying values, in no small part, has opened up an opportunity for you now: a lower stock price on a long-term performer pushes the odds in your favor.
I like the dividend, I like the company's 17%+ return on equity from last year, I like the fact that this is a company that practices disciplined pricing first, followed by growth.
Dad, usually I get you a shirt. Doesn't a commercial mortgage-backed security sound tons better?
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Bill Mann got a shirt. At time of publishing he held shares of Allied Capital. The Motley Fool is investors writing for investors.
A Stock for Dad represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts.