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Dear Investors,
For a few months now I've been assuming you'd rather I stay more focused on managing the portfolio than writing about it. So, I've been a little slow in blogging and writing these letters. I do have quite a bit to update you all on, though, and I'll be back on a regular schedule now to do just that.
First things first - our performance. The Tarpon Folio rose 9.8% in September, compared to a rise in the benchmark S&P 500 of 8.8%. As measured from the beginning of its second year, Tarpon is down 7.3%, compared to a negative 4.6% return on the S&P 500 over the same period. So, early in the year we were up, then during a volatile summer, we dipped, and now Tarpon has bounced back a bit. The broader market didn't dip as much this summer.
As measured from inception in 2008, we're still significantly outpacing the benchmark, and looking ahead, I wouldn't trade Tarpon for that benchmark even with a couple of first round draft picks thrown in. More on that shortly.
Interestingly, the high-yield Gecko Folio has continued to grind upward this year, even after a brief spike in the wrong direction in May due to the Greece debt crisis. From the first of the year to the end of September, Gecko is up 18.8% in 2010 and still yields a touch over 7.0%. Investors are understandably putting a premium on dividends this year, and that has helped push Gecko higher. I'll have more on Gecko in a future update. The stock market this summer resembled the hurricane season in 2005 here in the Keys. We had four storms back then - not unlike the flash crash, Greece crisis, Gulf oil spill and Goldman Sachs fraud allegations, you might say. Those storms also came right on top of each other, and by the end of that summer, many folks here had a bad case of hurricane fatigue. I suspect many of you are similarly exhausted after this summer's constant drone of headlines…“Something About Tax Cuts or Earnings or Money Or Something.”
It was, simply, a strange summer. The market seemed to be driven by computerized trading and sensational headlines, and that volatility was enough to cause at least one veteran portfolio manager to call it quits. The Dow Jones has recorded 90 trading days this year with moves of 100 points or higher. We saw the worst August in the market in 9 years, not to mention the worst May in 16 years. We also just finished the best September in the market since 1939. Even Chuck Yeager would be nauseous. Pundits continue to declare the death of fundamental value investing and obsess over macroeconomic concerns. It seems everyone, everywhere hates stocks. So, well, I've buying hand over fist. Ah-hem. I essentially reinvented the Tarpon Folio this summer. At times I imagine checking your accounts was like watching sausage get made. I looked at more companies than I care to remember. I repeatedly went over everything we already owned. We eased our way into a few new small, dramatically undervalued companies. I cut loose some companies that I long admired to put money to work in even better, cheaper companies. And more than once I started taking a position, paused, spotted another even more promising candidate, and ended up settling on that even newer name. (Remember, we don't pay commissions). For a few days there, I felt like a trader. One time, I even almost turned on CNBC. It was dreadful. Then, when the pessimism seemed to reach a peak, the market turned. And here is where we are now: 1 - The price-to-fair-value ratio of the Tarpon Folio is very favorable. Tarpon is a cheap asset. 2 - There is still no double dip recession. 3 - The return we could achieve in Tarpon may exceed my own expectations. My valuations assume relatively low growth over the next few years. If our companies grow more than I expect, however, a future annual meeting could involve setting something on fire and shooting our pistols into the air. Considerable fiscal challenges still exist for the country. As I mentioned in that June article, we must get thrifty again. But we still have time to address those issues - and I suspect the public is now developing the political will to do just that. To paraphrase another fund manager, my job is to identify good companies that most investors are objectively wrong about; figure out what those companies are really worth; wait until they're as cheap as possible, and then invest aggressively. As you might have guessed, trying to gauge when a price might be at its lowest is the hardest part, and I've blown that a few times - and likely will again. Fortunately, it's a mistake from which we can recover. I'll explain the concept of averaging down in a future blog post. One of the more common questions I got over the summer was with regards to the level of cash inside the portfolio. As I've mentioned previously, I assume each of you holds your cash somewhere else - at the bank, for instance, or in a tin can in the backyard. And unlike many mutual fund managers, I can exit or enter most positions in our portfolio very quickly. So I don't typically feel the need to hold lots of cash in Tarpon. And I wouldn't have remained fully invested in Tarpon this summer if I didn't think it would ultimately increase our returns in the long-term. Allow me to explain. I think my philosophy on cash in the portfolio can best be explained in two words: Garrett Wittels. Wittels is a shortstop on the Florida International University baseball team. This spring, he tied Joe DiMaggio's famous 1941 streak of hitting in 56 consecutive baseball games. FIU's season ended with Wittels two hits short of the NCAA record of 58 games (set by Robin Ventura at Oklahoma State in 1987, Mr. Trebek). Fortunately, he will get to resume his record-setting attempt next season when he returns to the team as a junior. Hitting a baseball with any kind of consistency is, to me, one of the most challenging feats in athletics. Of the many factors that explain Wittels' success, there's one that seems to be a particularly apt metaphor for investing these days. As a younger hitter, it turns out Wittels had trouble hitting curve balls. So intimidated was he by the sight of a hard-thrown ball coming directly at him that he'd often scamper right out of the batter's box before the pitch would break. After exhausting all other means to break his son of this habit, Wittels' father, in apparent desperation, decided to build cement walls around three sides of the batter's box in their backyard. This left Garrett nowhere to go when the curve ball came. And then he began to hit it. This summer I essentially dragged all of you into a batter's box with me to wait for the best pitches the market would give us. I imagine to some of you newer investors, watching your accounts may have felt a little like being walled off in a cement batter's box. But when things aren't really as bad as the masses believe, holding a lot of cash in a portfolio is like scampering into the dugout. I believe we absolutely have to stand square in the box because - and there's no other way to say this - the pitcher was out-of-his-mind drunk. Schnockered. Toasted. Blottoed. We were going to see some great pitches. And we did. Now it certainly got a little wild in there. Balls were sailing all over the place. We got plunked now and again when the wind blew hard. That won't matter a few years out, though. I'll take a few on the chin if it means I can keep buying Lowe's at $20 a share. And I'm pretty sure I can keep waiting for those perfect pitches longer than that pitcher can keep drinking. I stand by the paper I wrote in June - the economic recovery is real, though hard to see. We certainly won't be wading in streets of confetti anytime soon, and I suspect things will feel uncomfortable for another six months or so. But - look away now, compliance officer! - here's the thing: We are going to make a lot of money on this portfolio. The caveat is I have no idea how long it's going to take to do that. When I put Tarpon together in 2008, I was pretty confident that it would double in value, but my expectation was that it would take five years. It ended up only taking 13 months. As I sit here today, I'll also tell you that in several ways, Tarpon is now a better portfolio. We are getting some great deals on even better world-class companies. I also believe I have a high level of competency in evaluating the businesses of many companies which had especially volatile share prices this summer, which should bode well for our future long-term returns. So, despite all the angst and emotion in the market the past few months, this has been a remarkable summer in terms of getting good prices on great companies. At times, the degree of difficulty was pretty high, but it's important to keep this in mind: The single most important factor that determines your ultimate investment returns is - by far, without equivocation, asterisk or footnote - the price you pay. And the only reason you're ever able to get really good prices on an investment is because most people want nothing to do with it. In other words, most of the heavy lifting in Tarpon has been done, and now it's time to sit back again. I'll write again at the end of the month with a little bit more about one of our newest companies. Thanks as usual for investing with me.
- Cale
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Cale's Notes: 