was wondering if the “pay option mortgages,” which are being offered by many lenders, are one of these products. These negative amortization and adjustable mortgages have been around for 25 years. Yet, they have not proliferated the marketplace in the past as much as they have the last several years. Lenders such as Countrywide, GoldenWest Financial and First Federal Financial have been using these riskier mortgages as a typical type of loan in 2005 and 2006. “Investors must recognize that the early success of an innovation is not a reliable indicator of its ultimate merit.” “Although the benefits are apparent from the start, it takes longer for the problems to surface.” “What appears

4

to be new and improved today may prove to be flawed or even fallacious tomorrow.”

“The eventual market saturation of Wall Street fads coincides with a cooling of investor enthusiasm. When a particular sector is in vogue, success is a self-fulfilling prophecy. As buyers bid up prices, they help to justify their original enthusiasm. When prices peak and start to decline, however, the downward movement can also become self-fulfilling. Not only do buyers stop buying, they actually become sellers, aggravating the oversupply problem that marks the peak of every fad.”

He later writes about investment fads. “All market fads come to an end.” He clarifies, “It is only fair to note that it is not easy to distinguish an investment fad from a real business trend.”

“You probably would not choose to dine at a restaurant whose chef always ate elsewhere. You should be no more satisfied with a money manager who does not eat his or her own cooking.” Just to reiterate, I do eat my own cooking, and I don’t “dine out” when it comes to investing.

“An investor’s time is required both to monitor the current holdings and to investigate potential new investments. Since most money managers are always looking for additional assets to manage, however, they spend considerable time meeting with prospective clients in addition to handholding current clientele. It is ironic that all clients, Present and potential, would probably be financially better off if none of them spent time with money managers, but a free-rider problem exists in that each client feels justified in requesting periodic meetings. No single meeting places an intolerable burden on a money manager’s time; cumulatively, however, the hours diverted to marketing can take a toll on investment results.”

“The largest thrift owners of junk bonds – Columbia Savings and Loan, CenTrust Savings, Imperial Savings and Loan, Lincoln Savings and Loan and Far West Financial, were either insolvent of on the brink of insolvency by the end of 1990. Most of these institutions had grown rapidly through brokered deposits for the sole purpose of investing the proceeds in junk bonds and other risky assets.”

I personally suspect that the same will be said of the aggressive mortgage lenders of 2005 – 2006. I have looked back at my files of 1stquarter 1980 Value Line for a few of these companies mentioned above. Here are some notes on one of the companies I found.

Far West Financial: Rated C++ for financial strength. In 1979 it was selling for 5/% of book value. “The yield-cost spread is under pressure.” “Lending is likely to decline sharply in 1980.” “Far West’s earnings are likely to sink 30 – 35% in 1980. Reasons: The deteriorating margin between yield on earning assets and the cost of money, less loan fee income…” Keep in mind that the stock price rose around 400% from 1974 – 1979. From 1968 – 1972 the P/E ratio was in a range from 11 –17. From 1973 through 1979 the P/E ratio was in a range from 3.3 – 8.1. It would be interesting for me to look at the 1990 – 1992 Value Lines of the same companies.

A Value Investment Philosophy:

“One of the recurrent themes of this book is that the future is

“One of the recurrent themes of this book is that the future is unpredictable.” “The river may overflow its banks only once or twice in a century, but you still buy flood insurance.” “Investors must be prepared for any eventuality.” He describes that an investor looking for a specific return over time, does not make that goal achievable. “Targeting investment returns leads investors to focus on potential upside rather on downside risk.” “Rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk.”

Value Investing: The Importance of a Margin of Safety”

“Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of the bargain is the key to the process.”

Full article here Notes_To_Margin_of_Safety