It was a great and a must-attend event.  What made it especially interesting this year was that most of the presentations for the conference were prepared several weeks prior, which normally would not matter, but the market tanked during that time.  Presenters, including many very distinguished value investors, identified stocks that were cheap when they prepared their slides, and then when presenting these stocks were in many cases 30% cheaper.  The lesson is that even stocks valued at 50 cents on the dollar can still go to 25 cents.  It is very difficult to pick the bottom.  Investing is not a sprint, it is a marathon.

A lot of discussion centered on the energy sector - oil and gas companies.  For this sector, I believe you have to “subnormalize” the earnings.  The last 3-5 years were based on oil at around $70/barrel.  As the global economy slows down, the price of oil will change dramatically.  We could see $30 oil (before we see $100 oil).  Demand is already slowing down, and alternative energy sources and consumption patterns are changing.  There are more of these changes to come.  In the last five years, high oil prices encouraged investment, but it takes a while for supply to come on line.  As these new sources come on line, it will depress the price of oil even further. 

When you buy an oil company, you buy oil in the ground, and you pay what it is worth based on the price per barrel.  Oil company valuations are based on the marginal cost of extraction.  As oil prices subside, the high marginal cost players will disappear.  To “subnormalize” means to look at how much will oil companies make (their earnings power) based on a long term recession (i.e. $30 oil prices).  

My crystal ball no better than anyone else’s, but I believe this is a high probability scenario and thus if you own oil or natural gas companies make sure you own low cost producers that have strong balance sheets.

High return on capital is great, but in today’s environment return of capital is what matters.  This is not a time to be a hero.  We are not making leveraged plays to make a lot of money.  We are being very conservative.

The meaning of what constitutes quality is being redefined today.  We are buying high quality companies with low valuations (a large “margin of safety”), a lot of cash, and low debt.  A lot of ex-dotcoms - technology companies - look attractive, since it is an industry that is deeply imbedded into the corporate structure.  If the economy slows down, corporations generally can’t cut back on technology usage.  New projects may slow down, but a lot of technology is based on recurring revenue.  That is what matters in this environment.  We expect that companies like Microsoft and Oracle will be able to buy competitors at attractive valuations.  They have bulletproof balance sheets.

We are very careful of consumer spending habits.  We don’t like industries (like automobiles) that sell products that require consumers to borrow money.  These industries have already been crippled.  If you buy a cyclical company, then you must normalize earnings and be very conservative in valuations, and make sure you are increasing required margin of safety.

It comes down to stock selection.  For example, we are concerned about Europe, but we own a British liquor company that has better fundamentals, a lower valuation and higher yield than its American counterparts.  It is likely to do better in this environment.  Our biggest concern is the “stuff” stocks (industrials, energy, and materials).  They were responsible for a good chunk of excess in corporate profit margins.  The analysts’ earnings assumptions are way too optimistic.  The only question about the recession is how big it will be and how long it will last. 

As I mentioned before, it is a stock picker’s environment.  We don’t know how long this drama will last, and thus we are not trying to be heroes.