For the first 6 months of 2004, our average account was up approximately +8.70%.
It was a quiet quarter in your portfolio, to paraphrase Garrison Keillor. Another 90 day stretch in which we made almost no trades is considered so out of the mainstream in the investment management business that we are thinking of publishing an attendance record for the two of us at the end of these letters, just to prove we are in fact showing up.
Levy, Harkins made a wonderful acquisition today, however, and we are crowing about it at the first possible instant. We hired Jim Lebenthal. This is Jim’s second tour of duty with us, and the first led to one of the more notable successes that we ever had, but we will get back to that in a moment. Jim comes from outstanding bloodlines in the investment world. His father is the municipal bond impresario behind Lebenthal & Company, and his grandmother Sayra, who founded the firm, we also knew, which shows how long in the tooth we are. When we got a phone call six years ago from James Grant telling us to hire young Lebenthal, we should have said yes on the spot. That it took us an hour to interview him shows how slow we are some days. Jim grew up on the West Side of Manhattan, attended a prestigious private high school, went to Princeton, graduated with a degree in molecular biology, and decided at age 22 he had never done enough for America. So he joined the United States Navy and served seven years in the submarine corps. We are, both of us, nervous in the subway. This was a really impressive interviewee.
Then we got to talking about investments. We had, at the time, an investment in a satellite company that was poorly managed, and a friend of ours was waging a proxy fight to oust the sluggardly management. Jim asked us why we were involved. We patiently explained the proxy rules, the likelihood of victory and the bounce we expected in the stock. Jim listened, and then muttered, “O.K. But they have the wrong kind of satellites.” They come in “kinds”? Well, yes; and the Navy teaches people something about this. After a half hour lecture from Jim about why geo-synchronous satellites were soon to be obsolete for voice traffic, which would all migrate to MEO’s and LEO’s obliterating our current investment utterly, he then went on to explain the nascent satellite television business. Echostar had just over 1 million customers at the time. They have over ten million customers today, which is also roughly the ratio our investment has grown. Jim hasn’t said anything in the few days he’s been here to top that, we don’t think, but we intend to listen very carefully in the years to come.
When we write that an interview does not need to last longer than an hour to tell you all you need to know about whether somebody “gets” value investing, we really are not kidding. Some people treat stocks as though they are gambling chits subject to hundreds of vagaries, and they are going to identify which vagary is the most important today and which way it breaks. This is by far the dominant view. Value investing treats shares as ownership interests in businesses, looks for managers who think the same way, and cheerfully confesses ignorance as to the short term direction of stocks. It is always an advantage to know that you do not know the stock market’s next move, and sometimes it is an enormous advantage to know nobody else knows either. Those are the moments we can focus on price when everyone else focuses on something else. Jim “gets” this, and it was obvious in twenty minutes. That he went on to get a business school degree from Wharton and worked for a few years in a leading investment bank won’t in the long run do him any harm at all.
While we are in the mood for confessing our penchant for happily taking credit for our staff’s brilliance, you ought to know about Jane Paik and Lucia LoScalzo. Jane is a special talent. There is much to know about the settlement of securities, some of them in far off places, the accurate keeping of accounts, the proper tax forms for them all, the new demands of the Patriot Act, and the predatory ways of brokerage houses. Jane oversees all of this for us, and with a stylishness and grace that has never betrayed a drop of sweat. Our style makes this the more amazing. Because we trade so infrequently, when we do act, it tends to come in blizzards. Never bothers Jane. When we are asked “How long can Levy, Harkins grow at these rates?” the last thing we think about is our back office. Jane has unlimited upside. We also need to tell you we did not teach her this. When her college roommate, Julia Choi, left us to go back to Korea and start a family she said, “Jane will be much better than I am.” As things worked out, she got barely three days of training. Eight years later we still frequently say to each other, “How does she know that?”
Maureen Walker was our first employee, and she left after 17 years. We trade people as infrequently as we trade stocks. When we settled on Lucia LoScalzo to replace her, it was with some trepidation. Although she had worked for us for more than a year, she was still less than 20 years old. We work in a heavily regulated business, and keeping the authorities fully informed means riding herd on lawyers, all of them twice Lucia’s age. What is more, in her task you cannot get it right 99% of the time. That will not do. How would you feel to get someone else’s monthly statement, and they yours? The skin crawls, and it is only one of a dozen things that could go wrong and doesn’t.
When you pay us a fee you are hoping to get good investment performance, but you are expecting to get well treated. Win or lose, you have a right to fair dealing and accurate reporting. We went on about this at some length in our annual letter to you, but in our angry screed about mutual fund practices we left out the roles Jane, Lucia and our staff play in our endeavor, and we want to own up to that mistake now.
We will close this letter with an update on an observation from our last letter. Everyone in the investment business has a hidden interest in minimizing the true extent of inflation. Bond issuers want you to believe that all of a given return is real, and money managers want to laud their genius at propelling you toward your financial goals without ever mentioning the following wind at their backs. For the first five months of 2004 the Consumer Price Index was up at a 5.1% rate if annualized, or a 3% rate if compared to the level of the same months last year. These numbers are utterly unbelievable. They do not pass the laugh test for anyone who has last year’s check book register laying at hand. The rate of inflation you pay is much higher than this. A frank acknowledgement of this puts quite a damper on the headline number we begin these letters with, doesn’t it? So while we are pleased with how we did in the first half, we know it isn’t quite what it looks like. What is worse, just because you need a higher return in inflationary times doesn’t mean you will get it. Indeed, the obverse is likely to pertain. Almost a hundred years ago John Maynard Keynes had this to say about the dangers of inflation:
“There is no subtler, no surer means of overturning the existing basis of Society
than to debauch the currency. The process engages all the hidden forces of
economic law on the side of destruction, and does it in a manner which not one
man in a million is able to diagnose.”
Keynes did not go on to tell us how inflation makes it harder to tell a good business from a bad one, or how it upsets the pricing of those businesses, but trust us, it does. The stock market may go up more if the Federal Reserve raises interest rates slowly, but it is fostering inflation in its lethargy, and in the long run that does none of us any favors.
Sincerely,
Edwin A. Levy
Michael J. Harkins