Wednesday, April 29, 2015

Apple's Cash

Apple (AAPL) has been returning, to say the very least, a whole lot of cash to shareholders since August of 2012:

From the inception of its capital return program in August 2012 through March 2015, Apple has returned over $112 billion to shareholders, including $80 billion in share repurchases.

The company's share count is down nicely as a result of the share repurchases and, based upon the expanded program, should continue to drop.* Yet, after returning the $ 112 billion, the company still has net cash and marketable securities of nearly $ 150 billion.

The key word here being "net". Total cash and marketable securities is actually more than $ 193 billion but, after subtracting debt, the number is more like just under $ 150 billion.

Consider the fact that net cash sat at roughly $ 117 billion just before this capital return program began. So the company has still been able to increase its net cash and marketable securities after allocating the $ 112 billion.

What's more astonishing is the fact that the company's net income was $ 1.3 billion on $ 13.9 billion of sales back in 2005.

Compare that to net income of 39.5 billion on sales of $ 182.8 billion in its last full fiscal year.

Those numbers are on track to be even higher in 2015.

I think it's fair to say that's quite a decade plus.

Now, the fact is Apple remains incredibly dependent on regular product innovation. What was highly competitive not long ago requires ongoing improvements just to remain competitive. I mean, they're not exactly selling soft drinks and snacks. Whether or not Apple can maintain its advantages and competitive position over the longer haul is, at least for me, a tough question to answer. The company may still be making great products many years from now but, even if they are, that doesn't guarantee today's outstanding business economics will be persistent.

An innovative company might continue creating quality products but, due to a changing competitive and technological landscape, what were once attractive returns on capital become much less so. It need not be something catastrophic for the core economics to be hurt in a way that's meaningful for long-term investors.

Charlie Munger, at the 2015 Daily Journal (DJCOshareholder meeting last month, was asked whether companies like Google (GOOG) and Apple have sustainable moats.

Part of his response was this:**

I am not an expert on the moats of technology companies. The reason, by and large, I don't own them is because I do not understand whether or not there are moats that will last or not.

He also added the following:

...anybody who does give you the answer is probably full of you know what.

Occasionally, certain tech stocks (incl. AAPL and GOOG) have sold at a big enough discount to my own (conservative) estimate of intrinsic value that I was willing to purchase some shares.

In other words, the price was such that there was a substantial margin of safety and not much had to go right.


Long position in AAPL and GOOG established at much lower than recent prices; no position in DJCO.

* Naturally, if the stock at some point sells for a premium to per share intrinsic value the plan to repurchase shares should be altered accordingly.

** From some excellent notes that were taken at the meeting. Well worth reading. Not a transcript.
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, April 22, 2015

Howard Marks on Valuations: "There's Nothing That Is Absolutely Cheap"

On CNBC earlier this month, Howard Marks had the following to say about the valuation of most assets:

"There's better and there's worse, but there's nothing that is absolutely cheap."

And later added...

"I describe most assets as being on the high side of fair."

He did also say that at least stocks are "not in the territory they were in 2000..."

Video: No compelling bargains right now, Oaktree's Marks

There are exceptions, of course, but it has become much tougher to find investments that are selling at a plain discount to value these days. The fact that they're not nearly as expensive as 15 years ago doesn't mean that finding assets with a sufficent margin of safety -- in order to buy meaningful amounts with warranted confidence -- is an easy thing to do right now. 

That doesn't mean I have an opinion on where prices are going. As always, I never do. It just means, for too many stocks, the current margin of safety makes establishing new positions, as well as incremental purchases of what's already partially owned, beyond token quantities, difficult at best.

Unfortunately, the valuation environment we are in does not reveal much of use about what direction stock market prices might go over the next several years. What's somewhat expensive can easily become even more so. Trying to guess near-term market moves (near-term being anything less than five years in my view) is a terrific waste of effort and focus.

What it does mean is that today's prices offer much more risk for a whole lot less reward.

Investing well requires, among other things, an ability to estimate value and price discipline. Several years ago -- and especially during the financial crisis -- it was not difficult to find shares of good businesses selling at a discount to a conservative estimate of intrinsic value. Some of my posts about stocks during that period more or less reflected that environment. It wasn't about timing. It was about market prices versus estimated per share intrinsic value. These days it's a very different situation. Bear markets -- or, at least, the prices that often become available during and sometimes after a bear market -- are an opportunity for the long-term investor.

"You make most of your money in a bear market. You just don't realize it at the time." - Shelby Davis

So, for those with a long enough time horizon, it makes little sense to hope for a bull market.

It feels more risky (and the headlines and commentators will do plenty to reinforce the feeling) to buy during a bear market but, if the assets are sound, the risks of ownership can actually be much reduced. A bear market -- usually accompanied by some form of macro turmoil -- is when risk and reward becomes more favorable even if temporary losses are almost a given.

It's worth mentioning attempting to avoid the temporary losses creates the possibility of a different kind of mistake.

A mistake of omission.

"The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it." - Charlie Munger

Munger describes this as "buying with an eyedropper things we should be buying a lot of."

The temporary loss might have been avoided but the possibility of buying too few shares (or, worse, buying no shares at all) of something at attractive prices when the opportunity arises gets larger. Permanent capital losses should be considered unacceptable but, at least with stocks, temporary losses are almost inevitable. The gains that were missed on those things that were well understood but weren't bought matter.*

For investors, it's not about what will happen in the coming weeks, months, or even years.

The emphasis should be on decades while knowing many unexpected things will happen and there's little point in trying to predict them.

Margin of safety, to some extent, can protect against uncertainty and misjudgments. An approach dependent on an unusual talent for guessing what's going to happen in the future, even if it involves using the most sophisticated tools and brainpower available, will likely work better on paper than the real world.

It's best to develop a flexible approach and to remain open-minded.

Investing involves lots of homework and lots of waiting.

It need not -- and I'd argue should not -- involve lots of transactions.

Those who choose to actively trade stocks aren't investing, they're speculating. Now, there's nothing inherently wrong with speculating on short-term price action. Some no doubt know how to do that sort of thing well but that's inherently a very different activity.


* There's almost always individual stocks that are cheap but doesn't mean they're understood well enough by the investor to buy. Buying what's not understood -- or worse, yet, confidently buying what someone thinks is understood but actually is not -- provides a great way to burn up a whole lot of capital. Only after the fact is something truly obvious. Missing a big gainer that's not fully understood by the investor is going to happen. That's not a mistake of omission. In fact, that's why, when I own shares of a good business that's been bought at a very attractive price, my preference is to NOT sell just because the shares happen to become more fully valued. Excessive buying and selling is a recipe for trouble. There are only so many good businesses that I can understand well enough. Others may be able to figure out more but I think some kid themselves that this is possible. When business prospects remain attractive then either opportunity costs or overvaluation must become substantial for selling to be warranted.
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, April 15, 2015

Berkshire's 'Big Four'

Warren Buffett, in his latest Berkshire Hathaway (BRKa) shareholder letter, wrote the following about what he calls the 'Big Four':

- American Express (AXP)
- Coca-Cola (KO)
- Wells Fargo (WFC)

"Berkshire increased its ownership interest last year in each of its 'Big Four' investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 7.8% versus 6.3% at yearend 2013). Meanwhile, stock repurchases at Coca-Cola, American Express and Wells Fargo raised our percentage ownership of each. Our equity in Coca-Cola grew from 9.1% to 9.2%, our interest in American Express increased from 14.2% to 14.8% and our ownership of Wells Fargo grew from 9.2% to 9.4%. And, if you think tenths of a percent aren't important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our ownership raises Berkshire's portion of their annual earnings by $50 million."

It's worth noting that there's no attempt to bet on exceptional growth here. Some seem to think that high growth is a necessity to generate high returns. Well, consider the kind of businesses (whether through common stocks or outright purchases) Berkshire has owned over the past several decades. For the most part the returns have come from businesses that were not dependent on high growth over an extended period. Also, the returns generally have not come from businesses in industries that experience lots of change and require continuous product innovation. Instead, the emphasis has been on owning sound -- even if rather unexciting -- businesses that will be around for many decades. Ultimately, it's about increasing Berkshire's portion of what those businesses earn over time and the power of compounding effects.

So it's an emphasis on what the business can produce (in excess cash) over time. Those who, more or less, attempt to cleverly buy and sell stocks in order to profit from price action -- often with a rather not long time horizon in mind -- are engaged in a very different activity.
(This is the case whether or not the decisions are based upon business fundamentals. The fact that fundamentals are considered doesn't necessarily mean the activity isn't more speculation than investment.)

This approach works best if the business franchise remains competitive while real but manageable challenges keep the stock cheap for an extended period. A languishing stock can be a very good thing. In fact, the long-term investor in shares of a good business does not -- or, at least, should not -- logically want the share price to rise near-term or even intermediate-term.

Buffett recently said that some have a "misconception when we buy a stock we like it to go up. That's the last thing we want it to do."

For the investor who plans to be an owner for decades a rising stock price is not a good thing. What's much preferred is if the shares persistently sell at a discount to per-share intrinsic value.* When that happens -- at least for a business with sound long-term core economics -- future results improve as intrinsic value gets transferred from those who are impatient to those who are less so.**

"Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient." - From the 1991 Berkshire Letter

A rising stock simply makes buybacks less effective and makes it tougher to accumulate more shares over time via dividend reinvestments or incremental purchases at a proper discount.***

Why Buffett Wants IBM's Shares "To Languish"

Ultimately, it's about the discounted per-share value of the excess cash that's produced as long as the business can at least maintain or, better yet, improve its competitive position.

Buffett explains in the latest letter that Berkshire's portion of the 2014 earnings from these four businesses "amounted to $4.7 billion (compared to $3.3 billion only three years ago). In the earnings we report to you, however, we include only the dividends we receive – about $1.6 billion last year. (Again, three years ago the dividends were $862 million.) But make no mistake: The $3.1 billion of these companies' earnings we don't report are every bit as valuable to us as the portion Berkshire records."

That's just one of the reasons why Berkshire's price to earnings generally isn't a terribly useful thing to consider.


Long positions in AXP, KO, WFC, BRKb established at much lower than recent prices. Long position in IBM established at slightly higher than recent prices.

Here's how Buffett explains intrinsic value in the Berkshire Hathaway owner's manual: "Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life."
** If a dollar of value is consistently bought back for 70 cents then the other 30 cents of value doesn't just disappear, it ends up being transferred to the continuing owners. So an intelligent buyback can lead to what is effectively an intrinsic value transfer from those too focused on near-term price action to those focused on per-share intrinsic value and long-term effects.
*** From the 2011 letter: "If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply.

Charlie and I don't expect to win many of you over to our way of thinking – we've observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus."
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, April 8, 2015

Index Funds vs Actively Managed Funds

Some recent research by S&P Dow Jones Indices found that, among other things, the vast majority of U.S. actively managed equity funds did not beat the relevant benchmark over ten years.

Here's a quick summary of U.S. equity fund performance over a ten year period.*

- All Domestic Equity Funds: 76.54% underperformed

- All Large-Cap Funds: 82.07% underperformed

- All Mid-Cap Funds: 89.71% underperformed

- All Small-Cap Funds: 87.75% underperformed

From the report:

"It is commonly believed that active management works best in inefficient environments, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA Scorecard. The majority of small-cap active managers have been consistently underperforming the benchmark over the full 10-year period..."

The results, with one exception, were similar for the 14 other U.S. equity fund categories included in the report.**

According to the report, "the majority of the active managers" that invest in international stocks also performed worse than their benchmarks over the same time frame.***

This should hardly be a surprising result. John "Jack" Bogle has been trying to educate others on the wisdom of low cost index funds over actively managed funds for decades.

Here's how Mr. Bogle once explained it:

"The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it's likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years...well, there's no data (yet!) on that!

But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index."

The S&P Dow Jones Indices research does "account for the entire opportunity set—not just the survivors—thereby eliminating survivorship bias." Any comparison that doesn't account for the funds that are liquidated or combined with other funds during a particular period isn't going to paint a realistic picture.

The research shows result for shorter time frames but, at least to me, ten years is barely a long enough time horizon to make meaningful judgments. It's performance over decades that matters all risks considered.

It may not be impossible to figure out which fund will outperform going forward over the longer haul, but at least investors should carefully consider just how difficult it might be.

Of course, it's possible that active managers are will do much better going forward but, if nothing else, some skepticism seems warranted.

Think of it this way:

Where else does a simple cheap product exist that offers the non-expert a chance to keep up with the experts -- or, if this research is any indication, possibly outperform the vast majority of the experts -- over the longer haul?

The tough part for many is avoiding the temptation to be more active than they probably should be and end up making inopportune portfolio moves.

Some investors tend to underestimate how excessive confidence and other factors can adversely impact results.

Some relevant Bogle advice:

1) " investing, realize that you get what you don't pay for. Whatever future returns the markets are generous enough to deliver, few investors will succeed in capturing 100% of those returns, simply because of the high costs of investing—all those commissions, management fees, investment expenses, yes, even taxes—so pare them to the bone."

2) "Don't do something, just stand there. Own American business...a broadly diversified portfolio of lots of companies and industries. Buy such a portfolio, never sell, and hold it forever."

3) "Invest for the long term—decades, even a lifetime—and start as soon as you can. No one knows what stocks will do tomorrow, or even what they'll do over the next few decades, but over the long pull, the dividends and earnings growth of American business will be reflected in rising stock prices."

He also says to avoid "stupid mistakes" including things like -- though not limited to -- making impulse investments, buying based upon tips, and letting emotions rule over reason.

Jack Bogle's market advice: 'Don't do something, just stand there!'

Ultimately, the "humble arithmetic" is unavoidable.


Related posts:
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again

* See page 4. Source: S&P Dow Jones Indices LLC, CRSP. Data as of Dec. 31, 2014. Charts and tables are provided for illustrative purposes. Past performance is no guarantee of future results.
** Large-Cap Value Funds: 58.76% of the funds underperformed their benchmark index over ten years. This may be a relatively better performance versus the other categories, but most funds in this group still could not outperform their benchmark.
*** Results on page 10.
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, April 1, 2015

Buffett on the Kraft Heinz Deal

Berkshire Hathaway (BRKaalready owned roughly half of Heinz as a result of a deal that took the company private back in 2013. Well, now Berkshire and 3G Capital have put a deal together that will combine Kraft (KRFT) with Heinz.

Berkshire and 3G together will own 51 percent of the newly combined Kraft-Heinz under the terms of the deal.

Berkshire had already invested $ 4.25 billion in Heinz common stock and will invest another ~ $ 5.25 billion in Kraft common stock to complete the new deal.

Warren Buffett explained it the following way on CNBC:


The $ 9.5 billion works out to Berkshire paying slightly less than $ 30 per share for Kraft-Heinz combined.

Buffett certainly views this as a VERY long-term investment:


Berkshire also still has the preferred stock investment in Heinz but most likely not for long:


The $ 8 billion of preferred stock pays a 9% dividend and was a part of the Heinz deal. Those preferred shares can be called at a premium after June 7, 2016.*

Boil this down and Berkshire paid a bit less than $ 30 per share for a stock that currently trades for ~ $ 88 per share. Of course, as Buffett points out, the $ 16.50 per share special dividend that will be paid before deal is completed should be accounted for to make a meaningful comparison.

Once paid the market price will, of course, adjust downward to reflect that special distribution.

Clearly that's quite a big discount to the current market price. Yet, that the shares were bought at such a discount to what it currently trades at isn't really what matters all that much. What's truly impressive is getting control of two rather large high quality franchises at what seems like a very fair price compared to current intrinsic value -- with value that should increase at a nice clip over time -- and the ability to put quality management in place. I'm guessing, though it already seems a fine deal compared to current value, what Berkshire paid for Heinz and Kraft will look rather very good against the value that will be created over many decades.

It's what the business will be worth many decades from now that matters.

It's worth pointing out that, at least by my math, the current market price seems to represent a rather full current valuation.

Naturally if this were more of a short-term bet that gap in price paid to the current market price would be more relevant. Well, plainly this is no quick trade so such a short-term gain means little since Buffett plans to hold it "forever". In fact, if that rather high market price were to persist it simply means that potential future share repurchases won't make much sense nor do much good for continuing shareholders. Almost all Buffett's investments are longer term in nature but any business that's purchased outright it's even more so. He makes it pretty clear that this investment, even though Berkshire will only own 26 percent plus of the common stock, is more like the purchase of a business outright versus a typical stock investment.
(Though certain stocks in the Berkshire portfolio tend to be held indefinitely if not "forever" while most others, at least, are held for a very long time. Mistakes get made that require a quick adjustment and sometimes the capital is needed elsewhere because the opportunity costs are high enough. Otherwise, short-term bets aren't really in the Berkshire playbook.)

More relevant is what was paid compared to what a reasonable estimate of what the two businesses are capable of earning on a normalized basis.

Heinz was earning roughly $ 1 billion per year before the company went private. Kraft as a stand alone company should earn $ 2 billion this year if expected earnings multiplied by current shares outstanding proves at least a reasonable guide.
(Heinz net income is currently lower due to the additional debt that was taken on as well as the preferred stock. It will take some time for the added debt to be paid down, along with the preferred shares, before this all falls to the bottom line for common stockholders.)

So, for roughly $ 9.5 billion, Berkshire now owns 26 percent plus of those earnings (and, for the time being, until they're likely called, will be getting that nice dividend payment from the preferred shares).

Seems like a more than reasonable price to pay for a business that should be around for a very long time.

If any of the expected annual cost savings come to fruition that'll only improve the picture.


No position in KRFT. Long position in BRKb established at much lower than recent prices. 

* See note 6, page 9 of the 2nd Quarter 2013 10-Q. Warrants were also included in that deal.
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.