Phone sex with Buffett

Phone sex with Buffett... Pro bono Bill Gross... Hedge funds terrified... Goldsmith on Smucker... When cash is a lie...

During a phone interview with CNBC, Warren Buffett divulged some of the details of his Goldman bid. It wasn't the first time Goldman had approached him for a deal... "They had sounded me out in the past, as everyone else had," Buffett said. The previous offer was "nothing I would say 'yes' to." Most of the embattled banks have called Buffett, including Bear Stearns the day before JPMorgan bought it.

"I'm calling about Bear Stearns," the man said, according to Buffett. "Should I go on?" Buffett commented later, "It's like a woman taking off half her clothes and asking, 'Should I continue?' Even if you're a 90-year-old eunuch, you let 'em finish."

The final Goldman call came from the firm's investment banker Byron Trott, who Buffett has twice praised in his shareholder letters. In 2007, Buffett called Trott "the rare investment banker who puts himself in his client's shoes," and wrote, "Charlie and I trust him completely." Buffett said he didn't look at Goldman's books before making the offer. He spent 15 minutes on the phone with CFO David Viniar, concluding, "It sounded fair."

Of course, Buffett can afford to trust his gut when he receives terms like those in his Goldman deal.

Is it fair for the investment banks that got us into this mess to make millions cleaning it up – by managing the $700 billion in distressed assets? Bill Gross, manager of the world's largest bond fund, doesn't think so. To make his point, Gross offered to help the government manage the toxic assets "free and clear." Gross, already a billionaire, said his firm PIMCO – with $830 billion under management – makes "fees aplenty."

Investors pay outrageous fees for hedge funds – usually 2% of assets and 20% of gains – in hopes the manager of their choosing will outperform the market. Investors expect hedge-fund managers to pick stocks, carry out complex derivative trades, and take part in private deals that the average investor can't. Now, investors are paying hedge funds to act as a passbook savings account. Citigroup estimates hedge funds have $600 billion in cash, more than one-third of all hedge-fund assets.

If you believe these people are better investors in the aggregate, this large cash position makes sense. Even Buffett said yesterday without Paulson's plan he'd never have invested in Goldman Sachs. He'd said he'd be selling, not buying.

What does AIG's failure mean for insurance pricing? Depends who you ask...

Insurance-ratings company A.M. Best says AIG's troubles would not harden the insurance market. Munich Re Group, the largest reinsurance company in the world, says AIG's problems would cause a reduction in reinsurance capacity, resulting in higher pricing, a hard market. A.M. Best is talking about the overall property/casualty insurance market, while Munich Re is talking only about the reinsurance market.

If you want to own a share of the third-largest reinsurer in the world, buy some Berkshire Hathaway.

To grab, or not to grab... The J.M. Smucker Company (SJM) is paying a $5 special dividend to shareholders on October 31. The ex-dividend date is tomorrow. S&A Dividend Grabber subscribers will receive a recommendation today. To learn more, click here...

New highs: none.

If you've got anything important to say about investing, or anything at all, send us an e-mail here: feedback@stansberryresearch.com.

"If Buffet is buying preferred Goldman securities but you recommend NOT piggy-backing and buying Goldman; is it safe to say that it would be wise to buy some or add Berkshire-Hathaway. Although most say I am relatively young at 36 years old; I have seen or been aware of very few stock that go up into the over 150.00 per share range and stay there for any extended period of time, based on that what do you see as the 5 and 10 year trading range(s) for Berkshire-Hathaway." – Paid-up subscriber Alan

Ferris comment: The nominal share price has little meaning. The stock can go to $1 million per share if the value is there. I recently recommended Berkshire Hathaway as my No. 1 pick in Extreme Value. As the credit markets remain sclerotic, investors will find out what it means to own a piece of a business that gushes cash and has a highly liquid balance sheet. The five to 10 year trading range is of no concern to me, since predicting share-price movements is impossible. I think the stock is worth $150,000 per share or more. It could, in my opinion, make you 10% a year for a decade or so. That's much better than you'll do in the vast majority of stocks.

I was pounding the table for Berkshire under $128,000. It's now around $134,000. I think there are a couple stocks everyone should own. Berkshire is No. 1. ExxonMobil is another.

"I don't know if Buffet ever had gold, but he did have 130 million ounces of silver for awhile, sold out in 2006." – Paid-up subscriber R.J.Gregorac

"The fact that Goldman is willing to write a covered call on their preferred shares @ the $115 strike tells me that they expect the shares to be priced at less than that 5 years from now rendering the calls worthless. I wonder who is going to come out ahead on this trade. The call speculator (Buffet) or the option writer." – Paid-up subscriber Murtaza

"Having read and enjoyed your loquacious retort to Dan Feinberg's September 24th explanation as to why net income is more important than cash flow, I would like to mention that one of the best accounting professional with who I ever had the pleasure of association used to love to say: 'What do you want it to be?' when he would be queried regarding the anticipated operating results for an upcoming period. One of the great pearls of wisdom that he imparted to be to aid in my investment decision-making process was: 'Cash can't lie, people do.' When I hear and read strained explanations extolling the virtues of apparently dismal results, that seem to fly in the face of common sense, I always reflect back on the comments from my trusted accounting friend.

"It seems to me that the current raging discussion over $700 billion was caused by exactly the same kind of specious argument being put forth by Dan Feinberg when he explains the supreme relevance of accounting practices over real money. Mr. Feinberg seems convinced that, just like the home buyers with no money down and a mortgage equal to 130% of their home's value, Goldman will be able to borrow it's way out of the current problem. Sounds like a plan. Not a particularly good one; but a plan none the less." – Paid-up subscriber Ken McGaha

Ferris comment: To readers of financial statements analyzing investment opportunities, cash can be as much of a lie as anything else. Remember Parmalat, the Italian milk company that nearly went out of business amidst a huge scandal back in 2003? It forged a multibillion-dollar cash balance. In other words, cash can and does lie. I've got a whole book about the subject on the shelf above my desk. It's called Creative Cash Flow Reporting, by Charles Mulford and Eugene Comiskey.

I also recommend you read Marty Whitman's Value Investing: A Balanced Approach. In it, Whitman writes, "In accounting terms, value investing treats every accounting number as being as important as any other number, with each number being derived from, a function of, and modified by all other accounting numbers."

Regards,

Dan Ferris

Medford, Oregon

September 25, 2008

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