Monday, February 28, 2011

Buffett: Sixfold Increase in Living Standards - 2010 Berkshire Shareholder Letter Highlights

From Warren Buffett's 2010 Berkshire Hathaway (BRKa) shareholder letter:

Last year – in the face of widespread pessimism about our economy – we demonstrated our enthusiasm for capital investment at Berkshire by spending $6 billion on property and equipment. Of this amount, $5.4 billion – or 90% of the total – was spent in the United States. Certainly our businesses will expand abroad in the future, but an overwhelming part of their future investments will be at home. In 2011, we will set a new record for capital spending – $8 billion – and spend all of the $2 billion increase in the United States.

Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of "great uncertainty." But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.

Don't let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.

We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.

When fear and uncertainty becomes pervasive, as it does seem to from time to time, it's worth keeping the above in mind.

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.

2010 Berkshire Shareholder Letter: "Trigger Finger is Itchy" for Major Acquisitions

Warren Buffett wrote the following in the latest Berkshire Hathaway (BRKashareholder letter:

We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.

Berkshire has roughly $ 38 billion in cash so there's plenty to put to productive use. The Federal Reserve has, of course, frozen dividend levels at major banks (strong or weak) during the last two years. In the letter, Buffett had the following to say about Wells Fargo's (WFC) dividend:

At some point, probably soon, the Fed's restrictions will cease. Wells Fargo can then reinstate the rational dividend policy that its owners deserve. At that time, we would expect our annual dividends from just this one security to increase by several hundreds of millions of dollars annually."

He expects a boost in dividends from many of Berkshire's stock holdings with Wells Fargo being the largest.

I'll have a more follow up posts early next week on what is an excellent letter. Buffett has written his fair share of quality stuff over the years but this letter might be the best one yet.

Adam

Long BRKb and WFC
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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.

Friday, February 25, 2011

Buffett: Fear & Greed Epidemics - Berkshire Shareholder Letter Highlights

Warren Buffett wrote the following in the 1986 Berkshire Hathaway (BRKashareholder letter:

"...when companies with good economics and good management sell well below intrinsic business value - stocks sometimes provide grand-slam home runs. But we currently find no equities that come close to meeting our tests. This statement in no way translates into a stock market prediction: we have no idea - and never have had - whether the market is going to go up, down, or sideways in the near- or intermediate term future.

What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease."

Finding businesses with favorable economics selling below intrinsic value is hard enough. Get that right and the short to medium term price action of an individual stock or the market as a whole doesn't matter all that much. Huge amounts of energy is put into trying to guess/predict near term price movements of individual stocks and markets.  It is, for the most part, a waste of brain power in my view.

If I buy a stock it's because the economics of the business seem sustainable and the price is low relative to my judgment of current value and likely future growth in value. Yet, I have no idea what the stock price is going to do in the short to intermediate term (though it's a bonus if after I buy a stock the price stays low or goes lower as a greater percent ownership of the profits and productive business assets can be inexpensively accumulated over time).

If correct in my assessment, the economics of the business itself will produce good results for me as one of the owners over a 5 to 10 year or preferably longer horizon. If I'm wrong, it won't. No trading required.

Figuring out what an individual business is worth and whether the favorable economics it has will be sustainable isn't easy but seems more doable than trying to make sense out of near term price action.

Adam

Long BRKb

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, February 24, 2011

Fairholme's Berkowitz on B of A, Goldman Sachs, and Sears

Bruce Berkowitz (named Fund Manager of the Decade last year by Morningstar) of Fairholme Fund (FAIRX) was recently interviewed by GuruFocus.

He speaks favorably about Bank of America (BAC) and points out, while banks will still be absorbing bad loans for a while, that loans by banks since late 2008 have generally been of high quality.

In the interview, he also speaks favorably about another one his larger financial holdings Goldman Sachs (GS).

He also mentioned that Sears (SHLD), a company heavily dependent on the housing sector, will end up being a good investment in the long run once housing has an upturn saying:

...Sears has become a real win-win, in that if Eddie Lampert does what most people expect he can do – improve the retailing of Sears – the stock will fly high and recognize that. If he can't, the stock price will continue to be volatile, very depressed at times, less depressed at other times, and eventually he'll have one share and we'll have one share, and there will only be two shares.

I like that last line. Buybacks benefit long-term owners significantly if consistently done when a stock sells at depressed levels (i.e. well below intrinsic value) using free cash flow over time. Apparently, Berkowitz has confidence that Eddie Lampert will apply good judgment in this area. The math is pretty simple yet buying back a cheap stock is too often underutilized as a means to add long-term shareholder value.*

Naturally this starts with being comfortable valuing the asset. Well, at least when it comes to Sears, I personally have no idea what it's intrinsically worth.

Lampert has in fact bought back more than $ 5 billion of stock over the past five years lowering the share count from 164 million (Oct. 2005) to 110 million (Oct. 2010).

More than 80% of the Fairholme Fund is now exposed to financial stocks. As far as I know that is more than any other non-financial sector specific money manager.

During the crisis Fairholme wisely had no exposure to banks.

Adam

Small long BAC position

* Unfortunately, the evidence seems to show that a number of companies have a tendency to buy high. Far too many buybacks occur when a company's shares aren't terribly cheap.

GuruFocus Interview
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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.

Wednesday, February 23, 2011

Isaac Newton, The Investor

As a follow up to this post, here's Jeremy Grantham's take on the South Sea Bubble and Sir Isaac Newton's participation in the folly.

"Newton had the great good luck to get into the South Sea Bubble early. He made a really decent investment and a very quick killing, which mattered to him. It was enough to count. He then got out, and suffered the most painful experience that can happen in investing: he watched all of his friends getting disgustingly rich. He lost his cool and got back in, but to make up for lost time, he got back in with a whole lot more (some of it borrowed), nicely caught the decline, and was totally wiped out. And he is reported to have said something like, 'I can calculate the movement of heavenly bodies but not the madness of men.'" - Jeremy Grantham in his most recent quarterly letter

Exhibit 4 in the letter is a chart that shows:

- Newton invests a small amount prior to the bubble
- Newton exits happy in the early stages before the bubble really gets going having made some money
- Newton sees his friends getting rich as the bubble does really get going
- So Newton re-enters near the peak of the bubble with a lot of money

Then, of course...

- Newton exits with the investment essentially a complete bust after the stock then falls roughly back to where he had initially invested just a small amount of money

Chart: Isaac Newton's Nightmare

Seems familiar enough. Newton's behavior nearly 300 years ago doesn't seem unlike what we saw from a number of market participants during the various bubbles of the past decade or so.

Successful investing is less about IQ and more about business sense, discipline, the right temperament, and knowing one's own limits.

Sir Isaac apparently lost what would be roughly $ 4 million to $ 5 million in current terms or practically all (if not quite all) of his stake in the South Sea Company. While the losses he suffered from the South Sea Company was enormous compared to his total wealth, he apparently still did not end up poor by any means. So the investment in South Sea Company itself was, give or take, basically wiped out (something like roughly 90% of his stake)
but it did not destroy Newton's entire fortune.

Of course, whether he lost a bit more (as Jeremy Grantham and Marc Faber suggest) or le
ss specifically isn't necessarily of the greatest importance. It's just a good example of how human nature can get the best of a very smart man.

Newton should have known better -- the basic arithmetic needed to figure out the extreme valuation wasn't hard at all compared to the complex mathematics (calculus) he at least helped to invent -- but envy and other aspects of his nature apparently led to a huge misjudgment.


Adam 

Related post:
Grantham on Bubbles

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, February 22, 2011

Time for Dividends in Techland

This Barron's article that five large tech companies including: Apple (AAPL), Microsoft (MSFT), Google (GOOG), Cisco (CSCO) and Intel (INTC) have net cash and securities equal to ~20% of their market cap. 

Many tech stocks financials are presented  using pro-forma earnings instead of those produced by generally accepted accounting principles (GAAP). Wall Street analysts will often do the same. The argument by management is usually that pro-forma is a better reflection of the company's economics.

Don't buy it.

This means the P/E calculated at most popular finance websites will look lower (i.e. due to inflated earnings) for those companies that follow this practice.

Cisco is one example. It looks cheap selling at 12 times current fiscal year earnings and even less including net cash. More from the article:

...those numbers don't include the $1 billion-plus—or 15 to 20 cents a share—that the company pays out to employees, through rewards of stock.

The article points out that most Street analysts will ignore this expense. It also mentions that Microsoft and Intel are examples of tech companies that do not follow this practice. They report GAAP earnings.

GAAP has its own limitations but pro-forma earnings isn't sufficient since stock-based compensation is material (especially for companies like Cisco and Google who use stock options extensively) and carries real costs for shareholders.

Here's a summary of the price to earnings excluding net cash for the following tech companies:

P/E Ex Net Cash
Apple: 12.9
Microsoft: 9.2
Google: 15.2
Cisco: 8.9
Intel: 9.0

There's a useful table at the end of the Barron's article that summarizes the price to earnings excluding net cash and other numbers for all the above tech companies (and some other tech companies).

So the above numbers provide a starting point. On the surface, each company looks reasonably valued or even cheap. In my view, Microsoft and Intel are examples of stocks that need little in the way of adjustments to get a clear picture of earnings.

Some others certainly do.

Depending on the amount of stock-based compensation those earnings adjustments can easily amount to 10-20% of lower earnings (and higher P/E).

Other adjustments may result in lower P/Es. Some argue that Yahoo!'s (YHOO) P/E is actually much lower than the one shown above when adjustments for cash and securities are made.*

There is a long list of other reasons why adjustments often need to be made to make the accounting more economically meaningful.

Unfortunately, there's no way around the fact that even when proper GAAP accounting is used it ends up only being a starting point.

Adam

Long Microsoft, Apple, Google, and Cisco

* The equity method in GAAP requires that the proportional earnings of an investment in a company's stock (or stocks) to flow through Yahoo!'s income statement. (Generally this method is applicable when ownership exceeds 20 percent but, as with just about everything in accounting, it's somewhat more complicated.) I've seen some examples when intrinsic value is being counted twice. For example: putting a multiple on the consolidated earnings -- including earnings from equity investments -- then adding the market value of equity investments. That's double counting.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational and educational use and the opinions found here should not be treated as specific individualized investment advice. 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.

Monday, February 21, 2011

Buffett On Pricing Power

During an interview with the Financial Crisis Inquiry Commission (FCIC)*, Warren Buffett had the following to say about the importance of pricing power when evaluating a business:

"...the single most important decision in evaluating a business is pricing power."

He added that when you can "raise prices without losing business to a competitor...you've got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent (laughs), then you got a terrible business. And I've been in both and I know the difference."

Pricing power might result from structural changes to the competitive landscape of an industry**, or by having well-known brands (fast-moving consumer goods: FMCG) with wide distribution like Pepsi (PEP), Coca-Cola (KO), Procter & Gamble (PG), and Kraft (KFT).

During the interview, Buffett talks about the reason for Berkshire Hathaway's (BRKa) investment in Moody's (MCO). Once again, the attractiveness of Moody's as an investment comes down to pricing power that stems from the company's large percentage market share.

In contrast, consider the U.S. airline industry:
  • Intense rivalry among many competitors
  • No significant barriers resulting in ease of entry into the industry by new competitors
  • Frequent industry overcapacity
  • Cheap substitutes to air travel (especially over short distances)
It all adds up to lots of buying power for airline customers and little to no pricing power for the airlines.

Intense price competition among too many players.

There's some additional reasons why most airlines (if not all) are very unattractive businesses beyond the aforementioned lack of pricing power. Airlines are capital intensive businesses that have to deal with significant supplier power (i.e. just two major manufacturers - Boeing and Airbus), large yet unpredictable fuel costs (with little control over those expenses), and high fixed operating costs (operating leverage).

Add in some financial leverage and you've got one of the toughest businesses to manage. The combination of excessive financial and operating leverage makes the earning power of any business very sensitive to even small changes in revenue.

So airlines would seem to have just about everything you don't want in a business. The possibility does exist for an airline with the lowest cost structure to do relatively well against competitors, but that doesn't make it a good business. The lowest cost airline is usually just the best house in a bad neighborhood at any given point in time. It might be a good business for an airline but it's not a good business more generally.

The risk/reward for investors is much more favorable with the best companies in other industries.

Adam

Long positions in NSC, PEP, KO, PG, KFT, and BRKb

* A bunch of expert interviews (including Buffett's) can be found on the FCIC website. Collectively, these interviews are a useful way to better understand the financial crisis.
** The current consolidated structure of U.S. railroad industry (Norfolk Southern: NSC, Union Pacific: UNP, CSX: CSX, and Berkshire's BNSF Railway) comes to mind. Until more recently, the industry had too many competitors for there to be attractive business economics.
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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.

Friday, February 18, 2011

ConocoPhillips CEO's Novel Idea: Share the Wealth

ConocoPhillips (COP) is a company that, after a decade long acquisition spree and often paying steep prices for assets, is now in the process of shrinking itself to create wealth for shareholders. It's shedding low return assets and allocating that capital to higher return places (including the purchase of its own cheap stock). 

This Wall Street Journal article early last year summarizes some of the specific assets Conoco will be selling.

The sales should generate around $ 15 billion for Conoco. The funds were to be used in part to increase the dividend and buy back the stock.

Some excerpts from the following article:


It would be cheery to see a CEO admit that the purpose of the public company he or she temporarily runs is to create wealth for shareholders. And not to perpetuate either the CEO's job or the company itself.

While I'm waiting for that unlikely event, I'm going to take what cheer I can from ConocoPhillips CEO Jim Mulva saying that, in the short term, the best way for this oil company to create value for shareholders isn't to chase high-cost opportunities to look for oil but to pay off debt, buy back shares and raise the dividend so that the company puts cash in the hands of its shareholders.

Consistent with this, ConocoPhillips recently announced another dividend increase and an additional stock repurchase.

Considering the huge gains since the announcement of these programs, the window to buy the stock cheap is closing rapidly.

Unlike the recent moves by Sanofi-Aventis (SNY),  every lever that is available to ConocoPhillips is now being used to create shareholder value instead of growth for its own sake.



To be fair Conoco made a lot of mistakes over the past decade (essentially buying high and selling low) and only recently has become more disciplined. Maybe the same thing will eventually happen at Sanofi.

Adam

Long position in ConocoPhillips established at much lower prices
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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.

Thursday, February 17, 2011

Peter Lynch: The "Cocktail Party" Theory

This Minyanville article written by Jeff Saut covers Peter Lynch's "cocktail party" theory. It's from the book One Up on Wall Street

Basically, during and after an extended bear market, no one at the party wants to talk about the stocks. 

Here's an overview of how Lynch says in his experience things progress over time.

A quick summary of Lynch's theory:

Stage 1: At the party, the markets been down a while and people are not talking about stocks. There's little interest in talking to an equity mutual fund manager like Lynch about it. When folks generally seem inclined talk to about plaque with a dentist than about stocks it's likely the market is about to head higher.
Stage 2: People may talk about stocks long enough to say they're risky but would still rather not talk about it. Party conversations are still more plaque than stocks and the market's up roughly 15%. Few care.
Stage 3: Market is up 30%, people start asking a professional money manager like Lynch what stocks to buy. Most have now bought a stock or two.
Stage 4: People are crowded around Lynch but now they are telling Lynch what stocks to buy. Dentists are now offering stock tips. This stage is a good sign the market is near a top.

What stage are we at now? In the article, Jeff Saut goes on to say we are certainly not near stage 3 or 4 yet. Who knows. I certainly do not. The business of guessing what the market as a whole is going to do is a tough one.
(Determining what a business is worth and paying a price safely below that value seems, by comparison, more doable to me.) 

To me, economic and market forecasts aren't usually all that useful (especially my own). Yet, among those who do make forecasts, Saut's opinion and insights are worth keeping an eye on. 

Check out the full version of Lynch's theory in Saut's 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, February 16, 2011

Sanofi-Aventis to Buy Genzyme for More Than $ 20 Billion

The good news, at the very least, is Sanofi-Aventis (SNY) shareholders no longer have to worry about the price going even higher.

Sanofi-Aventis is acquiring Genzyme (GENZ) for $74 a share, or roughly $20 billion plus a contingent value right.

Sanofi-Aventis to buy Genzyme

Each shareholder will also get a contingent value right if certain targets are met for certain treatments. I happen to think even the initial offer of $ 18.5 billion was too high.

At the agreed price, Genzyme is selling for nearly 40x this years earnings which, of course, looks expensive.

At the projected forward earnings the deal looks much more reasonable at 20x. If that kind of earning power is there with steady growth to follow then the price paid becomes quite a bit less unreasonable.

Yet, in the context of Sanofi's significant free cash flow and very low P/E multiple, the argument for the deal looks weak to me from a shareholder return perspective. I understand that Sanofi-Aventis needs growth but the price paid for growth relative to what the company's own stock can be repurchased at matters.

At today's prices, Sanofi's stock is there for the taking at ~7.5x earnings*.

From this past weekend's Barron's article on Sanofi-Aventis. So what's the CEO Chris Viehbacher's objective?

RX: Bust Up Big Pharma

"It's to get back to a P/E of the S&P 500...".

Later in the article, Viehbacher had this to say about buybacks...

In an argument rarely made by CEOs, Viehbacher says that if there is an investor perception that a company has a declining profit base...then buybacks aren't effective. Only if there is a more positive view are buybacks valuable. By this reasoning, companies should buy back higher P/E stocks, not lower ones.

The article makes the point that buying back their own stock at 7x earnings instead of buying Genzyme at 20x probably makes more sense. At least some investors would prefer it.

The question is: does a CEO utilize every lever available to create shareholder value or instead focus on growing the empire in the guise of creating shareholder value?

Sometimes buying another company makes sense. If your business has a 30 P/E and great business comes along at a low multiple you buy it.

With a 30x multiple, in most cases buying your own stock isn't the greatest option unless there's a reasonable probability of strong growth (growth, that is, w/high return on capital) for years to come. Clearly, Sanofi stand alone doesn't have favorable growth prospects but its low P/E presents an opportunity.

Now, I realize the best argument for the Genzyme deal is that Sanofi is, in fact, buying an asset with lots of growth in front of it. If that's the case, Sanofi's move may not be a disaster and could even work out okay. Still, on a risk/reward basis I'd certainly vote for buying back that cheap stock.

When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended." - Warren Buffett in the 1984 Berkshire Hathaway (BRKaShareholder Letter

By making repurchases when a company's market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management's domain but that do nothing for (or even harm) shareholders. - Warren Buffett in the 1984 Berkshire Hathaway Shareholder Letter

At 7.5x earnings, buying the stock at these prices provides a solid margin of safety while avoiding all the risks that are inherently part of any acquisition.

Here's a related post on Sanofi-Aventis from last year.

Sanofi-Aventis: How Not to Spend $ 18.5 Billion

This older Barron's article points out Sanofi's CEO blasted conference call participants about buybacks last year and said:

"I personally don't believe that buybacks add any shareholder value."

The article provided a quote from one big investor who was critical of drug-company CEOs:

"For these types, buybacks are a pejorative, a 'going out of business strategy' equated with no growth or ambition. Of course, the ambition to grow value per share instead of all the other stuff seems to escape many of them. I wonder how it's possible that so many well-educated people can be so ignorant of some pretty basic math."

With that view of buybacks I wouldn't expect a change in approach at Sanofi-Aventis anytime soon. While this may turn out to be a decent deal, it doesn't make the buyback lever any less important for Sanofi. If the stock stays cheap, it makes sense to take some of the free cash flow produced in the coming years to buy some of that stock.

So Sanofi's CEO says he wants "to get back to a P/E of the S&P 500".

Of course, that's what any CEO should want over the long haul but in the short to intermediate term, not necessarily.

I say be careful what you wish for, and, just in case the P/E adjusts upward sooner than later use some of the free cash flow to buy that stock on the cheap while you can.

While the price remains below intrinsic value (as Buffett says: "$ 2 of present value for a $ 1"), it gives a competent capital allocator another way of increasing returns for long-term shareholders.

You never know when the window to buy shares below intrinsic value will close.

Adam

Long position in BRKb and SNY

* Of course, one of the reasons for that low P/E multiple may be concern that the CEO has a track record of overpaying or will overpay for assets in the future.
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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, February 15, 2011

Berkshire Hathaway 4th Quarter 2010 13F-HR

Berkshire Hathaway's (BRKa) 4th Quarter 2010 13F-HR was released yesterday. Changes to the stock portfolio are as follows:

Equities Purchased
The only position Buffett continued to build upon is the portfolio's 2nd largest position, Wells Fargo (WFC), adding 1.8% to Berkshire's sizable stake. The total value of that position now stands at $ 11.6 billion (~21% of equity portfolio).

Ther are no entirely new positions this quarter.

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

Equities Sold
Buffett sold all shares of the following stocks:
Berkshire also reduced stakes in BNY Mellon (BK) and Moody's (MCO).

The value of the shares sold in the above stocks combined represents roughly $ 1.3 billion or just under 2.5% percent of the entire equity portfolio value. 

Portfolio Summary
After the changes, Berkshire Hathaway's stock portfolio* is made up of  ~ 41% financials, 41% consumer goods, 6% consumer services, and 5% healthcare. The remainder is primarily spread across industrials and energy. 

Top five holdings:
  1. Coca-Cola (KO) = $ 12.6 billion (23.3% of the portfolio)
  2. Wells Fargo (WFC) = $ 11.6 billion (21.4%)
  3. American Express (AXP) = $ 7.1 billion (13.0%)
  4. Procter and Gamble (PG) = $ 5.0 billion (9.2%)
  5. Kraft (KFT) = $ 3.2 billion (5.9%)
These top 5 represent approximately 73% of the ~ $ 54 billion equity portfolio value at yesterday's prices. Overall, the changes were minor this quarter with Buffett closing 8 relatively small positions (small in the context of a $ 50 billion+ stock portfolio) while trimming 2 others and using some of those funds to buy more Wells Fargo.

So it's a slightly simpler, more concentrated portfolio.

Consider the fact that of the 8 closed positions only Nike was worth more than $ 300 million with the others each below that threshold. It's possible (even likely) that these sales are related to the recent retirement of Lou Simpson, who quietly managed the smaller GEICO investment portfolio at Berkshire for decades, in preparation for the addition of Todd Combs. Buffett has said previously that positions in the $ 200-300 million range were typically those of Lou Simpson. From the 2004 Berkshire Hathaway Shareholder Letter:

"Lou Simpson manages about $2.5 billion of equities that are held by GEICO, and it is his transactions that Berkshire is usually reporting. Customarily his purchases are in the $200-$300 million range and are in companies that are smaller than the ones I focus on." - Warren Buffett

Initially, Combs is expected to manage just $ 2-3 billion of the entire Berkshire Hathaway Portfolio. As of the last 10-Q (the best view available until the annual report comes out), the combined value of the Berkshire portfolio including the above equities plus fixed maturity securities and other investments is roughly $ 117 billion** (excluding cash).

In addition, there is another $ 34 billion plus in cash. That pile of cash grows by $ 10 billion in a bad year so there will be no shortage of money to manage at Berkshire.

Adam

Long positions in BRKb, KO, WFC, AXP, PG, KFT, and LOW established at lower than recent market prices. Established long position in BAC and MCO near current market prices.

* 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. The status of those shares (BYD, POSCO, Sanofi, Tesco etc.) will be updated in the upcoming annual letter.
** This portfolio, of course, excludes all the operating businesses that Berkshire owns: MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking among others. In addition, the company owns insurance businesses (BH Insurance, General Re, GEICO, etc.) that provide plenty of "float" for investments.
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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, February 14, 2011

Barron's: ...And the Award Goes to Apple!

From Barron's latest ranking of the The World's Most Respected Companies.

Here's the top 10:
1 Apple (AAPL)
2 Amazon (AMZN)
3 Berkshire Hathaway (BRKa)
4 IBM (IBM)
5 McDonald's (MCD)
6 Google (GOOG)
7 3M (MMM)
8 Coca-Cola (KO)
9 Pepsi (PEP)
10 Procter & Gamble (PG)

The list of all 100 companies is here.

Among the companies that had the biggest drop in the rankings over the past year was Johnson & Johnson (JNJ).

With all the quality control issues at Johnson & Johnson the stock has remained inexpensive (some would say for good reason). There's no question the problems have done some reputation damage to the franchise.

It may not be completely clear just how extensive that damage will become but, in order to buy a very good franchise at a discount, you rarely have the luxury of waiting for the dust to settle. At current prices, unless the problems become materially worse I still like Johnson & Johnson for the long run even if I have to deal with some ugly headlines (and prices quoted by Mr. Market) for a few years. 

"The best thing that happens to us is when a great company gets into temporary trouble... We want to buy them when they're on the operating table." - Warren Buffett in Businessweek

Among the top 10, only Amazon stands out as a business that is not at all cheap at 75x trailing earnings and 59x forward earnings. The other 9 may not be cheap but at least don't seem plainly overvalued at current market prices.

Check out the full Barron's article.

Adam

Long positions in AAPL, BRKb, GOOG, KO, PEP, PG, and JNJ
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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.

Friday, February 11, 2011

Grantham on Bubbles

Here's an excerpt from Grantham's most recent quarterly letter:

"...asset bubbles don't spring out of the ground entirely randomly. They usually get started based on something real – something new and exciting or impressive, like unusually strong sales, GDP, or profits, which allow the imagination to take flight. Then, when the market is off and running, momentum and double counting (among other factors) allow for an upward spiral far above that justified by the fundamentals. There is only one other requirement for a bubble to form, and that is a generous supply of money."

Grantham later adds...

"Any value manager worth his salt can measure when there is a large bubble. To avoid exploiting bubbles is intellectual laziness or pure chickenry and is a common failing, in my opinion, in otherwise sensible and suitably brave Graham and Doddites.

I unabashedly worship bubbles. One of the very early ones – the famous South Sea Bubble – is shown in Exhibit 4. It's beautiful, isn't it? The shape is perfect."

Exhibit 4 in the letter is a chart that shows:

- Newton invests a small amount prior to the bubble
- Newton exits happy in the early stages before the bubble really gets going having made some money
- Newton sees his friends getting rich as the bubble does really get going
- So Newton re-enters near the peak of the bubble with a lot of money

Then, of course...

- Newton exits with the investment essentially a complete bust after the stock then falls roughly back to where he had initially invested just a small amount of money
The world has progressed in all kinds of ways over the past three hundred years or so. Yet human nature, the behavioral tendencies that move prices in the short-to-intermediate term, hasn't changed much if at all.

Sir Isaac apparently lost what would be roughly $ 4 million to $ 5 million in current terms or practically all (if not quite all) of his stake in the South Sea Company. While the losses he suffered from the South Sea Company was enormous compared to his total wealth, he apparently still did not end up poor by any means. So the investment in South Sea Company itself was, give or take, basically wiped out (something like roughly 90% of his stake) but it did not destroy Newton's entire fortune.

More on Isaac Newton in a follow up post.

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, February 10, 2011

Buffett Wisdom

Some miscellaneous quotes by Warren Buffett:

"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results." - Warren Buffett

"...it is not necessary to do extraordinary things to get extraordinary results." - Warren Buffett

"An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business." - Warren Buffett

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett

"An investor needs to do very few things right as long as he or she avoids big mistakes." - Warren Buffett

"...a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem as was the case many years back at both American Express and GEICO. Overall, however, we've done better by avoiding dragons than by slaying them." - Warren Buffett

"With enough inside information and a million dollars you can go broke in a year." - Warren Buffett

Sounds simple and straightforward enough even if it's not always easy to do.

Not staying within one's limits, cognitive biases, and the wrong kind of temperament often get in the way.

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, February 9, 2011

Fairholme Fund Portfolio Update

Both the Fairholme Fund (FAIRX) and Yacktman Fund (YACKX) have been among the best performers among equity funds over the past decade.

YACKX*: 11.81% annualized 10-year return
FAIRX: 11.68% annualized return
S&P 500: 1.85% annualized return

With such similar results one might expect at least some overlap in terms of what they tend to own. 

Let's compare.

In this recent post, I noted the top five holdings of the Yacktman funds with the top five stocks make up ~35-40% of the portfolio.

Yacktman Funds Sector Weighting
23% Media
21% Healthcare
19% Consumer Staples

Less than 3% of the funds exposed to financial stocks.

Fairholme's top five holdings look very different based upon his recently reported portfolio update.

In fact, it would be tough to be more different.

Just under 50% of the portfolio is made up of the top five holdings.

Fairholme Fund Sector Weighting
79% Financials
7% Consumer Services
6% Industrials

Check out this post to see a summary of the recent changes made to the Fairholme portfolio.

So Fairholme has a 79% weighting toward financials compared Yacktman having less than 3%.

Based upon current top holdings and recent actions, clearly these two top portfolio managers are taking divergent paths to achieve future results.

Both funds are obviously run by managers with great long-term track records but very different approaches.

Though both are impressive the contrast in styles is worth pointing out: Fairholme style tends to require higher turnover while Yacktman has a lower turnover approach and, in general, tends to own stocks that allow the portfolio to put Newton's 4th Law to work.

Adam

* Yacktman Focused (YAFFX) performed slightly better with a 12.32% annualized return over the past ten years.
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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, February 8, 2011

Buffett: Building A Company of Giants - Berkshire Shareholder Letter Highlights

An excerpt from Warren Buffett's 1986 Berkshire Hathaway (BRKa) shareholder letter:

"Charlie Munger, our Vice Chairman, and I really have only two jobs. One is to attract and keep outstanding managers to run our various operations. This hasn't been all that difficult. Usually the managers came with the companies we bought, having demonstrated their talents throughout careers that spanned a wide variety of business circumstances. They were managerial stars long before they knew us, and our main contribution has been to not get in their way. This approach seems elementary: if my job were to manage a golf team - and if Jack Nicklaus or Arnold Palmer were willing to play for me - neither would get a lot of directives from me about how to swing.

Some of our key managers are independently wealthy (we hope they all become so), but that poses no threat to their continued interest: they work because they love what they do and relish the thrill of outstanding performance. They unfailingly think like owners (the highest compliment we can pay a manager) and find all aspects of their business absorbing.

(Our prototype for occupational fervor is the Catholic tailor who used his small savings of many years to finance a pilgrimage to the Vatican. When he returned, his parish held a special meeting to get his first-hand account of the Pope. 'Tell us,' said the eager faithful, 'just what sort of fellow is he?' Our hero wasted no words: 'He's a forty-four, medium.')

Charlie and I know that the right players will make almost any team manager look good. We subscribe to the philosophy of Ogilvy & Mather's founding genius, David Ogilvy: 'If each of us hires people who are smaller than we are, we shall become a company of dwarfs. But, if each of us hires people who are bigger than we are, we shall become a company of giants.'

A by-product of our managerial style is the ability it gives us to easily expand Berkshire's activities. We’ve read management treatises that specify exactly how many people should report to any one executive, but they make little sense to us. When you have able managers of high character running businesses about which they are passionate, you can have a dozen or more reporting to you and still have time for an afternoon nap. Conversely, if you have even one person reporting to you who is deceitful, inept or uninterested, you will find yourself with more than you can handle. Charlie and I could work with double the number of managers we now have, so long as they had the rare qualities of the present ones.

We intend to continue our practice of working only with people whom we like and admire. This policy not only maximizes our chances for good results, it also ensures us an extraordinarily good time. On the other hand, working with people who cause your stomach to churn seems much like marrying for money - probably a bad idea under any circumstances, but absolute madness if you are already rich.

The second job Charlie and I must handle is the allocation of capital, which at Berkshire is a considerably more important challenge than at most companies. Three factors make that so: we earn more money than average; we retain all that we earn; and, we are fortunate to have operations that, for the most part, require little incremental capital to remain competitive and to grow. Obviously, the future results of a business earning 23% annually and retaining it all are far more affected by today's capital allocations than are the results of a business earning 10% and distributing half of that to shareholders. If our retained earnings - and those of our major investees, GEICO and Capital Cities/ABC, Inc. - are employed in an unproductive manner, the economics of Berkshire will deteriorate very quickly. In a company adding only, say, 5% to net worth annually, capital-allocation decisions, though still important, will change the company's economics far more slowly."

It's a unique approach among large companies. It's tough to judge how successfully it will work beyond the Buffett and Munger era.

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.

Monday, February 7, 2011

Whitney Tilson's Two Largest Positions: MSFT & BRKa

Whitney Tilson talks his two largest holdings, Microsoft (MSFT) & Berkshire Hathaway (BRKa), in his latest letter:

We have recently been adding to Microsoft and Berkshire Hathaway, which are now our two largest positions.

He later added:
-The balance sheet is Fort Knox
-The company bought back $ 5.1 billion of stock during the quarter (a rate that retires 8% of its shares annually
- Net of cash, the stock trades for 10.1x trailing EPS

Despite all of this, the stock fell after Microsoft announced earnings, due no doubt to the consensus view that Microsoft is a fading giant, doomed to a future of lower market share, sales, margins and profits. It is of course possible to concoct such a scenario – people have been doing it for well over a decade – but there is no current evidence to support it. Microsoft’s market share in its key business areas is stable or rising, and sales, margins and profits are growing nicely.

A value-oriented investor with a large position in Berkshire Hathaway isn't exactly surprising.

On the other hand, the number of proven value-oriented investors that have accumulated shares in big cap tech stocks like Microsoft is, on the surface at least, a bit surprising. Most of these investors wouldn't go near tech a decade ago.

It's easier to understand after considering the margin of safety provided by what seems to be extremely low valuations in big cap tech land.

Adam

I have long positions in both MSFT & 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.
 
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