Bubble, Mania and Crash in 2002

The last few years have been some of the most exciting in the recent memory of investors. Unfortunately, they have provided many lessons, often expensive ones. Having only just come to terms with the catastrophe of September 11th, the financial world is witnessing several large bankruptcies and scandals. The world feels more and more risky as each day passes. It is difficult to know whom to trust.

In this uncertain world, Kurm still operates by the same values as when the company started. We only trust common sense. Our approach, one of investing in well-understood businesses, with predictable futures, honest managers who think like owners, and of only investing at a reasonable price, has meant that we have avoided many of the common mistakes of the last few years. The key ideas of investing with a “margin of safety,” seeing shares as pieces of a business, and seeing the stock market as a weighing machine, have proved very valuable.

While so many were investing in telecoms and technology companies with expectations of huge growth, we decided to abstain. Sky-high valuations for companies with small revenues, little or negative cash flow and yet-to-be-proven business models, as well as debt were avoided because the “margin of safety” rule means only investing in companies whose shares are significantly below their real, intrinsic value. Any businessman knows that it is cash and cash flow that drive value, but many analysts and bankers were paid very well while forgetting this basic notion. Many investors have lost millions because of bad advice and inexperienced managers.

Just because everyone else likes a share, it doesn’t mean it’s worth buying. Maybe in the short-term, as everyone “votes,” the price may rise, but in the long-run only the “weight” of the business, its assets and cash flows, determine value. As Benjamin Graham said: “In the short-run the market is a voting machine, but in the long-run it is a weighing machine.”

Kurm stayed away from many popular trends. The company was seen to be taking a risk by not taking advantage of the potential opportunities. However, ultimately, risk is about losing money. Buying an asset at an expensive price is very risky, as many have discovered: the money lost will not come back. Buying assets cheaply cannot be risky: even if the share falls temporarily, as long as we have good information, the money is safe.

Kurm has only invested in companies where there has been deep research and with a sound understanding of the business. This means that even when the market panics, we are well informed, and can take advantage of this fear. The quality, profitability and competitive advantage of the investee companies provides security.

Of particular relevance this quarter has been our emphasis on the honesty of the management and their thinking like owners. If they have a large portion of their wealth in the company, they are less likely to cheat: they lose if we lose. However, many companies pay management with options where, if the share price rises, they profit; but they do not lose if the share price falls. They thus have an incentive to take large risks with shareholders’ capital, our capital. With owner-managers or managers with virtually all their wealth in the business as partners whose reputation is impeccable, we are sure to benefit. This is the way to avoid disasters like Enron.

Turning to our specific companies, the recession and the state of the insurance industry are key factors. Fortunately, the price of insurance and reinsurance have risen making our investees more profitable going forward. There has been further turmoil in consumer finance, so that many companies have been forced to make large write-offs. However, Household has avoided these mistakes and remains profitable.

Generally, all our investees are well capitalised, conservatively run, low-cost businesses with very experienced and respected managers. They will be able to emerge from the recession with more market share, and will be able to take advantage of the weakness of others.

Once again, Kurm’s investment philosophy has proven resilient in difficult times.

20/5/2002

Kurm Investments Inc.                  46.5%

Dow Jones Industrial Average    25.8%

S&P 500                                                9.9%

NASDAQ                                              4.3%

The last three months have seen tremendous volatility in the world’s financial markets, despite which, the value of an investment in Kurm has grown. The last few years of patience and our conservative approach are paying off.

We have witnessed, and avoided, a mania, a bubble, in technology and telecoms, and a subsequent crash.  Now we are witnessing more and more chickens coming home to roost. Chairmen and directors are being forced to reconsider the huge undeserved pay packages which they earn even if the company does not perform. Some are resigning. The large investment banks are facing increasing scrutiny about their double standards regarding investment advice, caring more about fees than about investing clients’ capital. Many have lost their savings while others have grown rich taking advantage of them.

In this environment, Kurm has consistently applied the same approach. Many of these quarterly letters repeat the same message constantly. However, it is this consistent, constant, approach which will preserve capital and make it grow.

We continue to be invested in well-run, profitable businesses, run by honest managers who profit, as we do, be the value of their holding in the business rising. We invest in stocks as pieces of a business, and with a “margin of safety”.

As the outlook for the insurance industry improves, and as the markets understand this, and as bargains present themselves, we can expect Kurm to profit and its value to rise.

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