Tuesday, November 30, 2010

Favorite Rationalizations: Berkshire Shareholder Letter Highlights

Warren Buffett, in the 1982 Berkshire Hathaway (BRKa) shareholder letter, said the following about how management and directors often will rationalize issuing stock to purchase another company:

(a) "The company we're buying is going to be worth a lot more in the future." (Presumably so is the interest in the old business that is being traded away; future prospects are implicit in the business valuation process. If 2X is issued for X, the imbalance still exists when both parts double in business value.)

(b) "We have to grow." (Who, it might be asked, is the "we"? For present shareholders, the reality is that all existing businesses shrink when shares are issued. Were Berkshire to issue shares tomorrow for an acquisition, Berkshire would own everything that it now owns plus the new business, but your interest in such hard-to-match businesses as See's Candy Shops, National Indemnity, etc. would automatically be reduced. If (1) your family owns a 120-acre farm and (2) you invite a neighbor with 60 acres of comparable land to merge his farm into an equal partnership - with you to be managing partner, then (3) your managerial domain will have grown to 180 acres but you will have permanently shrunk by 25% your family's ownership interest in both acreage and crops. Managers who want to expand their domain at the expense of owners might better consider a career in government.)

(c) "Our stock is undervalued and we've minimized its use in this deal - but we need to give the selling shareholders 51% in stock and 49% in cash so that certain of those shareholders can get the tax-free exchange they want." (This argument acknowledges that it is beneficial to the acquirer to hold down the issuance of shares, and we like that. But if it hurts the old owners to utilize shares on a 100% basis, it very likely hurts on a 51% basis. After all, a man is not charmed if a spaniel defaces his lawn, just because it's a spaniel and not a St. Bernard. And the wishes of sellers can't be the determinant of the best interests of the buyer - what would happen if, heaven forbid, the seller insisted that as a condition of merger the CEO of the acquirer be replaced?)

Later in the letter Buffett goes on to say...

Managers and directors might sharpen their thinking by asking themselves if they would sell 100% of their business on the same basis they are being asked to sell part of it. And if it isn’t smart to sell all on such a basis, they should ask themselves why it is smart to sell a portion. A cumulation of small managerial stupidities will produce a major stupidity - not a major triumph. (Las Vegas has been built upon the wealth transfers that occur when people engage in seemingly-small disadvantageous capital transactions.)

A good relatively recent example of this is Kraft's purchase of Cadbury.

Adam

Long BRKb

Related posts:
Bankers & Barbers
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, November 29, 2010

The Banking Power Utility

Some excerpts from an article in The New Yorker:

"When the banking system behaves the way it is supposed to...it is akin to a power utility, distributing money (power) to where it is needed..."

The banking "power utility" should be, as it has in the past, funding new and existing industries.

"The other important role of the banking industry, historically, has been to finance the growth of vital industries..."

Unfortunately, these days, there's just too much reliance on trading.

For example, investment banking (advising businesses and raising capital for them) was less than 15% of Morgan Stanley's revenue during the first nine months of this year, sales/trading was more like 36% of revenue (and an even greater percentage of earnings).

"Goldman Sachs is even more reliant on trading. Between July and September of this year, trading accounted for sixty-three per cent of its revenue, and corporate finance just thirteen per cent."

So these businesses have changed "from businesses whose profits rose and fell with the capital-raising needs of their clients into immense trading houses whose fortunes depend on their ability to exploit day-to-day movements in the markets."

Is the amount of speculation built into the current system a good thing?

Lord Adair Turner doesn't seem to think so. According to the article he describes "much of what happens on Wall Street and in other financial centers as 'socially useless activity'".

Some is speculation is necessary, and maybe even desirable, but the proportion matters. A petrol engine needs, at least, roughly the right amount of air and fuel but, at some point, more of either in the mix will subtract from system performance. It is about optimization. A similar thing likely applies to the financial system. In other words, eventually more liquidity isn't such a wonderful thing. Worse yet, at least in some cases, is that some of the current activity amounts to little more than pure gambling. Speculation and gambling may seem like similar activities but they are far from the same thing.

A better balance sure seems needed. Far too much energy goes into what is, for the most part, socially not very useful (or, at least, economically mostly useless) in lieu of financing vital industries (the intelligent allocation and formation of capital) and otherwise providing the "power utility" function.

Check out the full article in The New Yorker.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, November 26, 2010

Shaq Still Dominates around Basket (of fries)

From an article in The Onion:
Celtics coach Doc Rivers said the 7-foot-1 center showed remarkable passion, screaming at opponents and throwing elbows in order to clear out the area in front of the basket of fries.

According to Rivers...


"Some people say that he's slowed down over the years, but he showed some real lateral quickness when he was defending his basket. He must have snagged about a dozen fries that I thought were out of his reach."

"He sent a clear message to the league tonight," Rivers added. "If you get close to that basket of fries, Shaq can still make you pay."


Check out the entire article.

Adam

Tuesday, November 23, 2010

Ackman's 3Q 2010 Letter

Some comments on Kraft and ADP from Bill Ackman in his latest letter:

Kraft 
We continue to like the "new Kraft" for its underappreciated international growth opportunities, as Kraft leverages Cadbury's well-established distribution network particularly in emerging markets. We also believe the company will significantly improve its profit margins, which are among the lowest of its peers. 

Thus far, our thesis appears to be on track. Year to date, base Kraft EBIT margins (excluding corporate expense) are up from 14.8% to 15.4%. We believe margins will continue to increase in the coming quarters, particularly as the company delivers its expected $750 million of cost savings from the combined Kraft/Cadbury operations. 

From a valuation perspective, based on the attractiveness of the categories in which Kraft participates, and its strong and growing emerging market presence, we think the stock is inexpensive at roughly 11x 2012 earnings.  

ADP 
The opportunity to acquire ADP at a discount to intrinsic value arose as ADP's earnings and cash flow weakened with the economy. Retention rates and new business bookings declined substantially as recession-related pressures drove some ADP customers into liquidation, led to headcount reductions, and otherwise delayed new business. Lower average client fund balances coupled with low interest rates also contributed to weakness in ADP's earnings. 

Later he added...

...ADP continues to wisely deploy capital in high-return acquisitions, substantial share repurchases, and dividends. Over the past five years, the company has repurchased more than 20% of its stock, made a number of intelligent acquisitions of complementary product offerings, while divesting non-core operations through sale or spinoff. 

Check out the full letter.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, November 22, 2010

Berners-Lee: Facebook Could Fragment Web

In an essay published this morning in Scientific American, world wide web founder Tim Berners-Lee is critical of the most successful social networking sites. In the essay, Berners-Lee accuses Facebook of creating a "closed silo of content" that risks fragmenting the web.

Excerpt from an article on the new Berners-Lee essay:

Facebook, LinkedIn and other social networking sites represent "one of several threats" to the future of the world wide web, its founder, Sir Tim Berners-Lee has warned.

Some of the web's "most successful inhabitants", such as Facebook and large telecoms companies, have begun to "chip away" at its founding principles, Berners-Lee wrote in a Scientific American journal essay published today.

Social networking sites that do not allow users to extract the information they put into them is a "problem" that could mean the web is "broken into fragmented islands", he said.

Google accused Facebook earlier this month of leaving its 600 million users in a "data dead end" with their contact details and personal information "effectively trapped".

Although Facebook recently began allowing users to download profile information including status updates and photos, the world's most popular social network has been roundly criticised for leaving users' network of contacts "walled" inside its own site.

Berners-Lee warned that such a "closed silo of content" risked leaving the web "fragmented".

"The web evolved into a powerful, ubiquitous tool because it was built on egalitarian principles," he said. "The web as we know it, however, is being threatened in different ways. Some of its most successful inhabitants have begun to chip away at its principles."

He added: "The more you enter, the more you become locked in. Your social networking site becomes a central platform – a closed silo of content, and one that does not give you full control over your information in it."

"The more this kind of architecture gains widespread use, the more the web becomes fragmented, and the less we enjoy a single, universal information space."

We are just shy of the 20 year anniversary of the world wide web. It went live in December of 1990 on Berners-Lee's desktop.

Adam

related article

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, November 19, 2010

Munger on Buying Gold

From this article:

"I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me that's not optional; that's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk." - Charlie Munger
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Some related posts on gold that may be of interest.
--
-Thomas Edison on Gold
-Grantham on Gold: The "Faith-based Metal"
-Buffett: Forget Gold, Buy Stocks
-Gold vs Productive Assets
-Grantham: Gold is "Last Refuge of the Desperate"
-Why Buffett's Not a Big Fan of Gold

A good business -- whether owned fully or partially -- is a productive asset.

Gold is not.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, November 18, 2010

Buffett, Unplugged

Some excerpts from a Wall Street Journal article from roughly five years back.

The article describes Buffett's approach to buying businesses and has a few other interesting insights.

Buffett offers to buy Forest River, a recreational vehicle maker, with the idea that the founder, Peter Liegl, would remain in charge.

So what happened?

The deal was closed a week later during a 20-minute meeting.

Buffett told the founder not to expect to hear from him much.

Here's what the founder said:

"It was easier to sell my business than to renew my driver's license." 

Later the article describes Buffett's daily routine. Apparently, it hasn't changed much over the years.

He says he spends the better part of most workdays thinking and reading. He fields a handful of phone calls, and on most days, he confers with the chiefs of a few Berkshire subsidiaries. He seldom holds meetings. "There isn't much going on here," he says of his office on a typical day. 

The article also points out there is no computer in his office though he does keep the financial news on.

He keeps no calculator on his desk, preferring to do most calculations in his head. "I deplore false precision in math," he says, explaining that he does not need exact numbers for most investment decisions.

Check out the full Wall Street Journal article.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, November 17, 2010

Buffett on Bankers & Barbers: Berkshire Shareholder Letter Highlights

Warren Buffett's thoughts on issuing shares of stock to buy another business from the 1982 Berkshire Hathaway (BRKa) shareholder letter:

Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty-cent pieces? Unfortunately, many corporate managers have been willing to do just that.

The first choice of these managers in making acquisitions may be to use cash or debt. But frequently the CEO's cravings outpace cash and credit resources (certainly mine always have). Frequently, also, these cravings occur when his own stock is selling far below intrinsic business value. This state of affairs produces a moment of truth. At that point, as Yogi Berra has said, "You can observe a lot just by watching." For shareholders then will find which objective the management truly prefers - expansion of domain or maintenance of owners' wealth.

The need to choose between these objectives occurs for some simple reasons. Companies often sell in the stock market below their intrinsic business value. But when a company wishes to sell out completely, in a negotiated transaction, it inevitably wants to - and usually can - receive full business value in whatever kind of currency the value is to be delivered. If cash is to be used in payment, the seller’s calculation of value received couldn't be easier. If stock of the buyer is to be the currency, the seller’s calculation is still relatively easy: just figure the market value in cash of what is to be received in stock.

Meanwhile, the buyer wishing to use his own stock as currency for the purchase has no problems if the stock is selling in the market at full intrinsic value.

But suppose it is selling at only half intrinsic value. In that case, the buyer is faced with the unhappy prospect of using a substantially undervalued currency to make its purchase.

Ironically, were the buyer to instead be a seller of its entire business, it too could negotiate for, and probably get, full intrinsic business value. But when the buyer makes a partial sale of itself - and that is what the issuance of shares to make an acquisition amounts to - it can customarily get no higher value set on its shares than the market chooses to grant it.

The acquirer who nevertheless barges ahead ends up using an undervalued (market value) currency to pay for a fully valued (negotiated value) property. In effect, the acquirer must give up $2 of value to receive $1 of value. Under such circumstances, a marvelous business purchased at a fair sales price becomes a terrible buy. For gold valued as gold cannot be purchased intelligently through the utilization of gold - or even silver - valued as lead.

If, however, the thirst for size and action is strong enough, the acquirer's manager will find ample rationalizations for such a value-destroying issuance of stock. Friendly investment bankers will reassure him as to the soundness of his actions. (Don't ask the barber whether you need a haircut.)

Once you've purchased a good business you have to observe carefully to see if management has a tendency to destroy value the way Buffett describes above. Unfortunately, this occurs far too often with very costly long-term effects.

Adam

Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, November 16, 2010

Berkshire Hathaway 3rd Quarter 2010 13F-HR

Berkshire Hathaway's (BRKa) 3rd Quarter 2010 13F-HR was released yesterday.

Equities Purchased
Buffett continues to build on his 2nd largest position, Wells Fargo (WFC), adding 5% to Berkshire's already sizable stake. The total value of that position now stands at $ 9.3 billion (~18% of equity portfolio).

He also increased Berkshire's holdings of Johnson and Johnson (JNJ). The stake was increased 3% bringing the total value of the JNJ position to $ 2.7 billion (~5% of equity portfolio). Currently, JNJ is Berkshire's 6th largest position. Buffett continues re-building the position after selling some of it off to make room for the Burlington Northern Santa Fe acquisition.

The only entirely new position is a very small one in BNY Mellon (BK) worth ~$ 55 million at current prices (barely more than .1% impact to the portfolio).

Here's a summary of other changes made to the portfolio this past quarter.

Equities Sold
Buffett sold all shares of the following stocks:
  • Home Depot (HD)
  • CarMax (KMX)
  • Iron Mountain (IRM)
  • Republic Services (RSG)
  • NRG Energy (NRG)
In addition, Berkshire reduced exposure to the following:
  • Comcast (CMCSK) - Cut stake by 98%
  • Ingersoll-Rand (IR) - Cut stake by 89%
  • Nike (NKE) - Cut stake by 52%
  • Nalco (NLC) - Cut stake by 33%
  • Fiserv (FISV) - Cut stake by 11%
  • Moody's (MCO) - Cut stake by 6%
  • Procter & Gamble (PG) - Cut stake by 2%
The shares sold in each of the above stocks represented less than one percent impact on the entire equity portfolio value. Other than P&G, none of these remaining positions represent a significant portion of the Berkshire Hathaway equity portfolio (MCO is 1.5%, all others less than 1%).

Portfolio Summary
At the end of 3Q, the equity portfolio* was made up of 41% consumer goods, 39% financials, 7% consumer services, and 6% healthcare. The remainder is primarily spread across miscellaneous industrials and energy. Top five holdings:
  1. Coca-Cola (KO) = $ 12.6 billion (approx. 25% of the portfolio)
  2. Wells Fargo (WFC) = $ 9.3 billion (18%)
  3. American Express (AXP) = $ 6.5 billion (13%)
  4. Procter and Gamble (PG) = $ 4.9 billion (9%)
  5. Kraft (KFT) = $ 3.3 billion (6%)
These top 5 represent approximately 71% of the equity portfolio value at yesterday's prices.

Adam

Long positions in BRKb, KO, WFC, AXP, PG, KFT, and MCO.

* Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside of the United States (i.e. shares in BYD, POSCO, Sanofi, and Tesco).
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, November 15, 2010

China's Stock Market

From a Jason Zweig article published in the Wall Street Journal last month:

...the leaders of China's Communist Party called for "accelerating the transformation of the nation's economic-development pattern." This drive to manage growth harks back to a declaration on April 22 that "of the many government functions, the most important is to facilitate commerce and help industries."

That was said on Aprill 22, 1903. 

So China's growth understandably creates excitement but:

...the Asian giant has run this exact race before—several times—and the results weren't pretty.

The growth in the Chinese economy is real, and I don't mean to sniff at it. But stocks require more than growth alone to be profitable; they also need good oversight by bureaucrats and corporate managers alike.

At the very least, this provides some historical perspective and food for thought.

Check out the full article.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, November 12, 2010

Grantham: High Growth Doesn't Equal High Returns

Here's an excerpt from a good interview with Jeremy Grantham on CNBC yesterday. During the interview he talks about the performance of the developed versus the emerging world.

"If you're going to grow at six [percent]...it is very appealing that you would outperform a world growing at two percent. And the developed world is slowing down...I say it has an incurable case of middle-aged spread.

It's just been there, done that. It's a little old. It's a little pastured. Doesn't have the population profile. Emerging does. And they have the attitude, and they have good finances. And— and they're really showing— a— a clean pair of heels to the developed world.

Now, it turns out that you— it's a bit more complicated. You don't actually find a strong correlation between— top-line GDP growth and making money in the market. It— it seems like you should. The fastest-growing countries should give you the highest return. They simply don't. But, there's only four of us— that— that believe that story. Everyone else in the world believes that if you grow fast like China, you'll outperform in the stock market." 
- Jeremy Grantham

Just another example of growth being of less importance for investor returns than paying the right price for a durable enterprise run by reasonably able managers (those that intelligently allocate capital most of the time).

Basically, buying at a discount what's capable of generating a nice return on capital for a very long time.

Growth, of course, will often have a favorable impact on value. 

It just happens to be a mistake to think that it always has a favorable impact. 

Growth can, in fact, actually reduce value if it requires excessive amounts of capital relative to the discounted value of the cash generated over time. Sometimes, the highest growth opportunities attract lost of capable competition and capital that ruins the long run economics. Sometimes, high growth requires costly but necessary capital raising (to fund investments, deal with emerging competitive threats) that dilutes existing shareholders and reduces per share returns.

Finally, even if growth that materializes does have favorable economics, some investors tend to pay a large premium upfront for those growth prospects. That hefty price paid may turn attractive long-term business results into not so attractive investment results.

Check out the full interview in this video.

Adam

Related posts:
Growth & Investor Returns - Jun 2010
Buffett on "The Prototype Of A Dream Business" - Sep 2009
High Growth Doesn't Equal High Investor Returns - Jul 2009
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, November 11, 2010

Fairholme Portfolio Update

Bruce Berkowitz, one of the top performing mutual fund manager's over the past decade, is now heavily invested in financials.

GuruFocus article

He now has 70% of his portfolio in banks and other financial stocks.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Bogle: Professional Security Analysts

From this recent morningstar interview with John Bogle:

"...I don't see why the Federal Government has an obligation to bail out investors who should know what they are doing. But even in the professional [money] management business, often seem not to know what they are doing. I'm disgusted and disappointed with the level of analysis I see among professional security analysts, bond and stock alike." 

Check out the full interview.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, November 10, 2010

"Accounting" vs "Economic" Earnings: Berkshire Shareholder Letter Highlights

Warren Buffett's thoughts on "accounting" vs "economic" earnings from the 1982 Berkshire Hathaway (BRKa) shareholder letter:

...financial statements reflect "accounting" earnings that generally include our proportionate share of earnings from any underlying business in which our ownership is at least 20%. Below the 20% ownership figure, however, only our share of dividends paid by the underlying business units is included in our accounting numbers; undistributed earnings of such less-than-20%-owned businesses are totally ignored.

Buffett later adds...

We prefer a concept of "economic" earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used - and not by the size of one's ownership percentage. If you have owned .01 of 1% of Berkshire during the past decade, you have benefited economically in full measure from your share of our retained earnings, no matter what your accounting system. Proportionately, you have done just as well as if you had owned the magic 20%. But if you have owned 100% of a great many capital-intensive businesses during the decade, retained earnings that were credited fully and with painstaking precision to you under standard accounting methods have resulted in minor or zero economic value. This is not a criticism of accounting procedures. We would not like to have the job of designing a better system. It’s simply to say that managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.

In most corporations, less-than-20% ownership positions are unimportant (perhaps, in part, because they prevent maximization of cherished reported earnings) and the distinction between accounting and economic results we have just discussed matters little. But in our own case, such positions are of very large and growing importance. Their magnitude, we believe, is what makes our reported operating earnings figure of limited significance.


At least some familiarity with the limits (and flaws) of an accounting system is useful. The numbers reported in SEC filings often must be converted into something that makes economic sense. It'd be nice if there was some absolutely correct set of numbers, but the investing process always comes down to making sound estimates of reality. Each company and industry has specific challenges. Beware of false precision.

"Better to be vaguely right than exactly wrong." - Carveth Read*

You can figure out whether company XYZ has return on equity (ROE) in the 20-25% range or free cash flow (FCF) is ~$ 950-$975 million. It's fantasy to think you can calculate that the ROE is precisely 23.4% or that the FCF is $ 963 million. Getting to a meaningful rough approximation is what counts.

Enrico Fermi thought the ability to effectively estimate (often called a Fermi estimate or Fermi problem) was an important skill for scientists and engineers to master.

Here's a previous post for some additional background.

One example of Fermi's skills at estimating: a remarkably accurate estimate of the strength of an atomic bomb blast during the Trinity test (of course, the first test of its kind) was made based on the distance travelled by pieces of paper he dropped from his hand upon detonation.

I think it's as useful a skill for investing as he believed it to be for science and engineering.

Adam

Long  BRKb

Related post:
Munger on Accounting

* This quote is sometimes incorrectly attributed to John Maynard Keynes even though the original source is apparently Carveth Read.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, November 9, 2010

Thomas Edison on Gold

In this New York Times article published back in 1921, Edison talks about paper money and gold.

"Now, as to paper money, so called, every one knows that paper money is the money of civilized people. The higher you go in civilization the less actual money you see. It is all bills and checks. What are bills and checks? Mere promises and orders. What are they based on? Principally on two sources - human energy and the productive earth. Humanity and the soil - these are the only real bases of money.

Don't allow [the bankers] to confuse you with the cry of 'paper money'. The danger of paper money is precisely the danger of gold - if you get too much it is no good. They say we have all the gold in the world now. Well, what good does it do us? When America gets all the chips in a game the game stops. We would be better off if we had less gold. Indeed, we are trying to get rid of our gold to start something going. But the trade machine is at present jammed. Too much paper money operates the same way. There is just one rule for money, and that is, to have enough to carry all the legitimate trade that is waiting to move. Too little or too much are both bad. But enough to move trade, enough to prevent stagnation on the one hand and not enough to permit speculation on the other hand, is the proper ratio." - Thomas Edison

A sufficient amount of currency to facilitate trade, invention, and other productive activities is needed.

Nothing more.

Adam

Related posts:
-Grantham on Gold: The "Faith-based Metal"
-Buffett: Forget Gold, Buy Stocks
-Gold vs Productive Assets
-Grantham: Gold is "Last Refuge of the Desperate"
-Why Buffett's Not a Big Fan of Gold

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, November 8, 2010

Deflation/Inflation & High Quality Businesses

An interview in Morningstar this past summer with Columbia Professor Bruce Greenwald.

Professor Greenwald explains why the Microsofts, J&Js and Coca-Colas protect investors with their ability to raise prices.

He also points out franchises like this are usually expensive but these days they are not.


Some of the stocks that he mentions in the interview have rallied a bit (in Coca-Cola's case quite a lot, actually) since this was published. Still, with a decent correction much of what he says remains the situation today if an investor has a long-term horizon.

Great individual franchises selling at reasonable valuations even if the market as a whole is not cheap.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Saturday, November 6, 2010

Bogle on Financial Innovation

From this John Bogle interview in Morningstar:

"...most innovations in the financial field are innovations of benefit for the innovators. They benefit the creators of them, the marketers of them. Wall Street benefits from most innovations and investors do not." 

Check out the full  interview.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, November 5, 2010

Buffett on Business Schools

"The business schools reward difficult complex behaviour more than simple behavior, but simple behavior is more effective." - Warren Buffett


Thursday, November 4, 2010

Short Sellers: "Don't Make Markets More Efficient"

Marty Whitman had the following to say about short sellers during an interview with Barron's:

In the history of man, the markets have never been better than they are now for shorts. But some of these fellows are out to destroy businesses, such as when a business needs continuous access to capital markets... 

He added...

Shorts, with present methods of communication that include blogs and cable television, might be able to bring any of them down. Because some of these value people are so good and so powerful, we at Third Avenue don't invest in companies that need relatively continuous access to the capital markets...

Whitman doesn't think short sellers help to make efficient markets:

They don't make markets more efficient. I think they could serve a real function. I am very concerned about their influence... 

I tend to agree. It doesn't make sense to vilify short sellers (which happens too often), but it's possible that the practice of short selling at times does more harm than good.

Think about it this way. We know price discovery happens during the sale of a private business or farmland without short sellers. So it's, at the very least, worth questioning whether short selling is as vital to price discovery for stocks as some seem to think.

Check out the full interview:

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, November 3, 2010

Grantham on Gold: The "Faith-based Metal"

Jeremy Grantham's take on gold in his latest quarterly letter:

"Everyone asks about gold. This is the irony: just as Jim Grant tells us (correctly) that we all have faith-based paper currencies backed by nothing, it is equally fair to say that gold is a faith-based metal. It pays no dividend, cannot be eaten, and is mostly used for nothing more useful than jewelry. I would say that anything of which 75% sits idly and expensively in bank vaults is, as a measure of value, only one step up from the Polynesian islands that attached value to certain well-known large rocks that were traded. But only one step up. I own some personally, but really more for amusement and speculation than for serious investing. It may well work and it may not. In the longer run, I believe that resources in the ground, forestry, agriculture, common stocks, and even real estate are more certain to resist any inflation or paper currency crisis than is gold."

3Q 2010 Letter
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Here are some related previous posts on gold that may be of interest.
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-Buffett: Forget Gold, Buy Stocks
-Gold vs Productive Assets
-Grantham: Gold is "Last Refuge of the Desperate"
-Why Buffett's Not a Big Fan of Gold

A good business -- whether owned fully or partially -- is a productive asset.

Gold is not.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, November 2, 2010

Google: A One-Trick Pony?

Recently, Google reported 3rd quarter revenues of $ 7.29 billion (a 23% increase compared to 3Q 2009) with search advertising still making up nearly 95% of that revenue. What's notable? Google is starting to get real traction in 2 or maybe even 3 (if you include the progress they're making with YouTube) other meaningful sources of revenue. These trends may suggest that the one-trick pony label will no longer apply in a few years.

"...if you've got a one-trick pony, you want the one we have. We’re in the ad business, and it’s growing rapidly. We picked the right trick." - Eric Schmidt

Some examples of new "tricks" from this ZDNet article:
  • Display ad annual revenue run rate is $2.5 billion.
  • YouTube is monetizing 2 billion page views a week, up 50 percent from a year ago. Executives were coy about YouTube profits, but the unit is clearly closer to where it needs to be.
  • Mobile is clocking an annual revenue run rate of $1 billion a year.
Consider that the current run rate of $ 1 billion for mobile revenue was less than $ 100 million around a year ago.

Google's Mobile Ads now a $ 1 billion Global Business

Impressive. Creating a new billion dollar business is difficult enough, yet it looks like they've done it with mobile in a very short amount of time.

Adam

Long GOOG

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Bogle on Corporate Governance

From a Morningstar interview with John Bogle:

"...one of the most serious problems we have in financial America, and that is what we call the agency problem, and that is that corporate America is no longer controlled by investors, its controlled by agents of investors. Used to be that mutual funds and pension funds and endowment funds controlled about 8% of all the stock in America.

Today, they control 70% of all the stock in America. Corporate America will march to their tune if they just wake up and say, here's what you're going to do; I am going to tell you what to do. Think of the difference if Corporation X had a single shareholder with 70%; there would be no question about who is the boss of that corporation. Forget who is Chief Executive, he doesn't count, the boss counts and the boss doesn't need any titles, doesn't need to be the Chairman, the President and the CEO. He owns 70% of the stock, he is the owner. That's the mood I want to get our institutional investors in, and I will keep trying." - John Bogle


Check out the full interview

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, November 1, 2010

Portfolio Theory & Diversification

From a Barron's interview with Marty Whitman:

On how important modern portfolio theory is to him:

"...as far as value investing, control investing, distress investing and credit analysis is concerned, that stuff is absolute garbage."


On the notion that portfolio diversification is important for downside protection:

"Again, in terms of value investing, control investing – though we are not control investors; we are a mutual fund—distress investing, credit analysis, this stuff is worse than useless."

Then later in the interview Whitman said:

"...diversification is a surrogate—and a damn poor surrogate—for knowledge, elements of control [of a company] and price-consciousness. If you are really a value investor and do deep research, how many investments can you be involved in at the same time? If you are a high-frequency trader, you could trade 100 securities today. The real value investors are lucky if they can do 10 investments at a time."


Tough to disagree.

Adam


This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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