CAZ Investments Quarterly Letter
Quarter 4 - 2008
Where does one start when trying to recap a year like 2008? Do we focus on the virtual collapse of the commercial banking infrastructure around the world? Should we spend time on the elimination of Bear Stearns, Lehman Brothers, Merrill Lynch and Washington Mutual? Maybe we concentrate on the disintegration of the largest insurance company in the world, AIG, and the nationalization of Freddie Mac and Fannie Mae? Finally, should we contemplate on the fact that 2008 was the worst year for stock markets around the world in two generations? My guess is that people would prefer to write 2008 off as a bad dream and focus on the future. We agree.
The most amazing thing for us, when we look back at 2008, is how the warning signs were there predicting the coming storm. We expounded on it to a great degree in our January 2008 letter, and we will detail those comments below. The thing that no one could have forecast, though, was the impact that the de-leveraging of the world economy would have on asset prices. To think that we ended up with what amounted to a worldwide margin call, as a result of the government’s decision to let Lehman Brothers fail, is truly mind boggling. Certainly, the government did not think it would get as bad as it did! When one looks back, though, with a self critical view of 2008, we see there were plenty of warning signs. To name a few:
What the world never seems to remember is that when prices start to fall, they always seem to fall much faster, and farther, then people possibly can foresee.
How Close Were We to Reality?
We say it every year and we will continue to say it, we really don’t like making predictions from a top down perspective. We are stock pickers, and we focus on what is happening at the companies first. We have to pay attention to what is happening at the macroeconomic level so we can make estimates of how those forces will impact our companies, but it is secondary to our company work. However, if we expound our view, it only makes sense to evaluate those predictions. Here is the exact reprint of our 2008 projections from last year’s letter, in italics, with the follow up of how that prediction turned out:
Here is what we believe will occur in 2008:
So Now What?
Here we go again! We don’t like going out on a limb with what we see for 2009, but people ask us to, so we are obliged to try our best to see the future. Here is what we think is possible for 2009:
The hard part about making projections is that there are so many variables. The thing that always surprises us is how people lose sight of how the results are always going to be centered on cash flow and valuations. Obviously, the macro variables listed above will have a HUGE impact on both of those, but ultimately if we get the cash flow change and valuation changes close to accurate, the results will be fairly precise.
We are forecasting an approximate 6% increase in cash flow for 2009. That will consist of an initial decline in the first half of the year followed by a recovery as a result of company cost saving initiatives and economic stabilization. That, coupled with a slight increase in valuations, could lead to a decent year of 8 – 10% returns. Naturally, the devil is in the details, and the fact that we are trying to put a number on this year in the midst of the incredible uncertainty would lead some people to wonder if we need our heads examined!
However, we pride ourselves in trying to simplify the complex. On November 20, 2009, we notified all clients that we felt that we were at the second “Buying Opportunity of a Generation”. The first time we used that phrase was on November 1, 2002. Many people asked how we could be so sure that November 20 was “the day”. The answer, of course, was that we could not be certain, but we felt strongly that a few things were going to happen in the future. First, we felt the world financial system was not going to disappear as we know it. Second, we felt that the economy would eventually recover and that good solid companies, like those we invest in, would generate cash flow that was higher than current levels. Third, we felt that investors would once again feel comfortable investing in high quality companies generating solid operating profits. The only thing we never pretend to be able to predict is “when”.
It is quite possible that our forecasts for 2009 could be wrong, but we emphatically believe that investors need to be buying stocks NOW! How can we be so sure about that? We feel cash flow generation by the companies in our portfolio will be at least 8% per year, for the next five years, and the number could be much closer to a 10% annual growth rate. Therefore, if valuations just STAY at the same levels they are today, which we would argue are a bit low, then we expect to make 8-10% on our portfolio over the next five years. Compared to the alternatives of CD’s, money markets and t-bills, that return is extremely attractive. In our opinion, investors have the best opportunity to own the best companies worldwide that we have had since November of 2002.
Every quarter for the last few years we have strongly advised investors to look at their portfolio allocation and make sure it is in line with their goals and objectives. This quarter is no different. MANY clients’ portfolios are now much more conservative than designed, and it is imperative that investors think about the growth of their purchasing power in the future. This is especially true if inflation is as much of an issue as we think it may be. Bonds and cash simply will not provide protection of purchasing power. Stocks can, and we believe they will. Please talk to us if you are not sure your allocation is where it should be.
Included with this letter is your 4th quarter Portfolio Review. The review includes a summary of your realized gain and loss information for the quarter AND for the entire year. The report is also broken down by short-term and long-term gains. So, for a taxable account, your tax preparation should be simple. When paired with the 1099 you receive from your custodian, you should have everything you need for your tax preparers. Do not forget that you can access all of your personal information online at our website: www.cazinvestments.com.
We appreciate the confidence you have shown in us. It was a tumultuous year, and we were incredibly impressed with the maturity and sophistication of our clients. Thank you for all the support. It was amazing how many calls we received from clients asking US if we were hanging in there. That was very gratifying and appreciated. Our firm is strong and healthy. We have great people who want to be the best they can be and do the very best job they can for you. We will continue to try and maximize returns for clients and look forward to a calmer 2009! We hope that this year brings many blessings to you and your family.
Christopher Alan Zook
Chairman and Chief Investment Officer