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I have two things to cover in this email. The comments of Seth Klarman and our deep water drillers; Atwood and Ensco.

In my December 14, 2009 email I wrote the following:

“My expectation is that the U.S. is in for another lost decade. I made money in the last lost decade and I am going to try to do so in the next. If it is not a lost decade, fine. That will make my job easier. If it is a lost decade, I need to be prepared and scared as I said in my last email.”

It seems I am not the only value investor with this thought.

 Seth Klarman

I have quoted Seth Klarman before. He is, by far, one of the best value investors ever. Klarman manages the Baupost Group. On Tuesday, Reuters had this to say:

He started the firm in 1982 with $27 million and has averaged 20 percent annual gains ever since. In 2007, amid the depths of the credit crash, Baupost had its best year, gaining 52 percent. Copies of Klarman's long out-of-print investment guide, "Margin of Safety," sell at auction for $700 or more.

I own Klarman’s book, it is right here on my bookshelf. I bought the book in 1991 when it came out. Not a bad investment return!

Klarman rarely speaks publicly, as the Reuters article points out:

Legendary fund manager Seth Klarman of the Baupost Group made some rare public comments recently at the CFA Institute in Boston.

And here are some of the comments he made according to the Reuters article:

“Given the recent run-up, I'd be worried that we'll have another 10 years of zero returns,"

Current market conditions remind Klarman of a Hostess Twinkie snack cake because "everything is being manipulated by the government" and appears "artificial."

"I'm more worried about the world broadly than I've ever been in my whole career," Klarman said.

Klarman has 30 percent of assets at his $22 billion Baupost Group in cash, he said.

Inflation is a risk that Klarman said he is particularly concerned with given the government's high rate of borrowing to bail out the financial system.

So, Klarman is being cautious with a 30% cash position. That is his way of being cautious. As you know, I have a different way. Our cash positions tend to be well above 50% (including FPA New Income). The average stock mutual fund cash percentage is down to a record low of 3%. If the stock market continues to decline those stock mutual funds will continue to get hammered.

Atwood & Ensco

Both stocks have dropped in price recently. This is a reflection of oil prices dropping from around $87 per barrel on April 6 to about $68 today, the decline in the stock market as the Dow has lost over 1,000 points from 11,309, and the disaster in the Gulf of Mexico with the loss of Transocean’s Deepwater Horizon drilling rig.

As I watch the prices decline, my only thought is; when do I buy? The price-to-earnings ratio of Atwood right now is under 7. The P/E ratio of Ensco is 7. Those are my kind of P/E ratios.

Ensco has $1.2 billion in Cash and only $257 million in long term debt. Their cash has increased by over $400 million since the end of 2008. Yes, a company that actually generates cash. That kind of company is very rare these days.

Ensco has a fleet of deepwater rigs that have been and are being constructed. The following chart shows the anticipated revenues the new rigs will bring to Ensco;

An additional $1.2 billion represents over a 30% increase from 2009 revenues. How many companies can you have faith in that their revenues are going to be increasing in the next few years?

Atwood, is in similar shape as Ensco.

Why don’t we just scrap off-shore drilling since we had such a disaster in the Gulf?

I’ve provided this before. Here is a chart from Matthew Simmons:

Global onshore production peaked way back in 1980. So, unless you want to go without new oil, you have to go to the ocean. Although I did like the cover of the Enquirer many years ago that informed me that oil had been discovered on the moon! You will also notice that shallow-water oil peaked in 1990. The world has no choice but to go deeper unless you want to tell 1.3 billion people in China that they can’t have cars.

When I am investing, I want aces up my sleeve. We have investments that make sense. I think they will do well in the years ahead. I cannot say that for the majority of stocks at current prices. Am I salivating a little? Yes. Although I am trying to be patient. I believe that oil prices have a good chance of declining further during the course of this year with further economic weakness showing.  That may be wishful thinking but, so far, things are going, to some degree, according to plan. At least I have a plan beyond the typical investment/portfolio manager who has one plan; the market will go up so don’t worry!

William Mason CFA