Wednesday, August 26, 2015

Competition & Moats

At the 2014 Daily Journal (DJCO) shareholder meeting Charlie Munger said:*

How many big companies stay totally on top forever? Maybe Wrigley's Gum.

Then later added...

It's a competitive world out there. Somebody is always starting something. Even for the branded goods makers, who looked so invincible for forty years. The natural course of competition is that it gets tough. It's the people who expect everything to just keep going wonderfully who are nuts.

So at least some of these businesses are not quite as bulletproof as they used to be. Part of the challenge, at least in certain cases, is coming from private-label alternatives.

Munger, back in 2013 (see pages 26-27), specifically mentioned Costco's (COST) private-label offering, Kirkland toothpaste, as an example of one threat.

Costco got one of the major toothpaste manufacturers of the world to make their toothpaste in Costco's tube at a very low price.

He also mentions the threat of Amazon (AMZN).

It's also possible for a new entrant to reach customers in an economically viable way that didn't really exist a couple decades ago. So enough scale to reach a big audience becomes less of an advantage.

What makes the situation even more challenging these days for investors is market valuation levels (even after the recent capital markets turmoil). Many of the consumer packaged goods businesses have gone from having reasonable equity valuations several years ago to fully valued and, in some cases, even expensive.**

That also doesn't mean they've, in general, suddenly become terrible businesses. Hardly. Some continue to have some very wide and likely rather sustainable moats. The very best of the small ticket branded goods makers appear to still have very sound businesses even if somewhat less so than the past several decades. Yet, like anything else, the price paid matters and right now few, if any, seem to be selling at a meaningful discount to per share intrinsic value.

I think Charlie Munger's point, more generally, is an essential one for just about any investor. No matter how good a business has been in the past, it's necessary to carefully consider how competition, technology, regulations, and customer behavior (among other things) could end up altering the core economics of a business over time.

The competitive position of any business -- and how it might be changing -- is an all-important consideration for equity investors. Most of what matters won't necessarily -- well, at least not early enough to be useful -- show up in the numbers. So financial statements and complex spreadsheets likely won't offer much insight. Sometimes, what matters most can't be measured in a meaningful way. It ends up being more about the qualitative factors.

In other words, an investor mostly won't be able effectively anticipate changes by simply looking at what can be quantified precisely.

What was once a wide moat can become much reduced, or even disappear altogether, over time. Sometimes it happens quickly; other times it's more of a slow degradation. The key is finding those businesses with very substantial and sustainable moats run by managers focused on making those moats more formidable.

Warren Buffett once said:

"We like to own castles with large moats filled with sharks and crocodiles that can fend off marauders -- the millions of people with capital that want to take our capital. We think in terms of moats that are impossible to cross, and tell our managers to widen their moat every year, even if profits do not increase every year."

Notice that moat widening is given priority over near-term profits.

It's NOT necessarily about growth unless that growth happens to be the high return variety over the longer run.***

It's buying, at the right price, shares of businesses with high returns on capital that will likely prove sustainable.

It's NOT just about returns.

It's finding sensible ways to reduce the risk of permanent capital loss.


No position in DJCO, COST, or AMZN

* From some excellent notes that were taken at the meeting. These notes, presented in four parts, are well worth reading. Not a transcript.

** Warren Buffett recently talked about valuation levels, speaking specifically about the larger food companies, while on CNBC. He clearly doesn't see them as inexpensive these days. Of course, the fact that they may be not at all cheap reveals little or nothing about what the near or intermediate term price action might be.
*** Not all growth is good growth for investors. Growth is but one component of value that -- while sometimes a positive -- is not necessarily a positive, though some seem to assume that's the case. There are slow growth businesses that produce attractive investment results and fast growth businesses that do not. Some of this comes down to the price paid upfront but that's only part of the story.
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, August 17, 2015

Berkshire Hathaway 2nd Quarter 2015 13F-HR

The Berkshire Hathaway (BRKa2nd Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.*
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 1st Quarter 13F-HR.)

Added to Existing Positions
U.S. Bancorp (USB): 1.3 mil. shares (1.5% incr.); tot. stake $ 3.69 bil.
Charter (CHTR): 2.5 mil. shares (42%); tot. stake $ 1.46 bil.

I've included above only those positions worth at least $ 1 billion at the end of the 2nd quarter. In a portfolio this size -- roughly $ 244 billion (equities, fixed income, cash, and other investments) as of the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.

One brand new position was also added during the quarter.

New Position
Axalta (AXTA): 20 mil. shares; tot. stake $ 662 mil.
(Previously announced.)

Not all of the activity has been disclosed. In the 2nd quarter of 2015, apparently some activity was kept confidential. Berkshire's latest filing says: "Confidential information has been omitted from the public Form 13F report and filed separately with the U.S. Securities and Exchange Commission."

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Reduced Positions
Positions that were reduced somewhat but not sold outright include WABCO (WBC), Chicago Bridge & Iron (CBI), and Viacom (VIAB) with each worth less than $ 1 billion.

Sold Positions
Positions that were sold include National Oilwell Varco (NOV) and Phillips 66 (PSX).

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.
(Though some of the holdings they're responsible for have become more substantial over time.)

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and, to a lesser extent, technology stocks (mostly IBM).

1. Wells Fargo (WFC) = $ 26.4 bil.
2. Coca-Cola (KO) = $ 15.7 bil.
3. IBM (IBM) = $ 12.9 bil.
4. American Express (AXP) = $ 11.8 bil.
5. Wal-Mart (WMT) = $ 4.28 bil.

As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.

The portfolio excludes all the operating businesses that Berkshire owns outright with ~ 340,000 employees (25 being at headquarters) according to the latest letter.

Here are some examples of Berkshire's non-insurance businesses:

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, Lubrizol, and Oriental Trading Company.
(Among others.)

In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.

See page 125 of the 2014 annual report for a full list of Berkshire's businesses.


Long positions in BRKb, WFC, KO, AXP, USB, WMT, and PSX established at much lower than recent market prices. Also, long position in IBM established at slightly higher than recent market prices. (In each case compared to average cost basis.)

* All values shown are based upon the last trading day of the 2nd quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F. What is not included are shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F is if Berkshire buys the ADR. Investments in things like preferred shares (and valuable warrants, where applicable, as explained in the recent letters) are also not included in the 13F. The same has been true for not only the Heinz (now Kraft Heinz) preferred shares, but also the common shares. A deal to combine Kraft and Heinz was announced earlier this year and closed on July 2nd, 2015. So, as a result, Berkshire will now own roughly 26.9% of the combined Kraft Heinz Company (KHC) with the stake being accounted for using the equity method. See Note 7 of in Berkshire's latest 10-Q for additional details. The investment will now represent one of Berkshire's largest positions.
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, August 11, 2015

Activists & the AmEx Buyback, Part I

On Friday of last week, the news broke that ValueAct Capital Management, an activist hedge fund, had taken a stake in American Express (AXP).

Some might think, since the stock rallied right after the announcement, that this should be received as good news by AmEx shareholders.

Clearly, for a trader (or someone who intends to sell their AmEx shares in near-term) that's understandably the case.

Yet a long-term investor in the stock shouldn't necessarily view this development as being a good thing. At most, until more is known, it logically deserves a more mixed reaction.

This has nothing specifically to do with ValueAct. They may be very good at what they do and, depending on their intentions and capabilities, could even prove helpful to AmEx's prospects over the long run.

Then why should the reaction be more mixed? Well, consider that the company has already announced it intends to repurchase "up to $6.6 billion of common shares during the period beginning in Q2 2015 through and including Q2 2016."

When a company is repurchasing stock in a meaningful way -- and for one with a market value just over $ 80 billion I think buying $ 6.6 billion of its stock over 5 quarters or so qualifies -- no long-term owner should be happy about the shares rallying. It simply means that, if the recent rally in price proves persistent (or worse...goes higher), the funds used in the AmEx buyback program will go less far and, as a result, the share count will drop by a smaller amount.

Plainly, all else equal, that is not a good thing for the long-term owner.

Also, if the rally were to continue higher, at some point the price might become such that it makes no sense to continue buying back the shares (i.e. as the price gets closer to per share intrinsic value). Again, that further rally might satisfy those who are in for the short haul but makes little sense for those who plan on being continuing owners of AmEx shares for a long time.*

It comes down to this: shareholders who prefer for their investment outcomes to be driven by what the business can produce in excess cash over decades will, inevitably, have a very different agenda than those who emphasize profiting from price action. Of course, the long-term investor will eventually want to see the share price at least roughly track changes in per share intrinsic value. It's just that a delay in the recognition can be hugely beneficial.

AmEx repurchased roughly $ 1.2 billion during Q2 2015. Not quite on pace for $ 6.6 billion but reasonably close. At least for now it appears they are following through on the plan.

Yet that's not what's most important. While sometimes a buyback plan will not become reality, it's the reason they don't become reality that matters.

Buybacks can make sense when both a stock is cheap -- i.e. selling at a nice discount to per share intrinsic value -- and available funds are more than sufficient to meet all the operational/liquidity needs of the business.

Well, at times, a buyback program will continue to be implemented even if one or both of these things no longer proves true.
(Worse yet is a buyback plan that's been put in place for the wrong reasons and is then implemented.)

Unfortunately, buyback announcements like this aren't always followed by wise action based upon changing circumstances.

How price compares to value and business needs (and how these things change over time) must be considered. Rigidity, at least when it comes to buyback programs but also more generally, isn't a virtue.

In business and investing flexibility often wins.

In other words, it's possible that circumstances will develop such that what was once a well-intentioned buyback plan shouldn't be implemented.

Back in May of this year, Warren Buffett spoke on CNBC about activist investors in the context of it's largest holdings (of which AmEx is one).

Keep in mind that he said the following well before ValueAct decided to invest in AmEx:

"I think it'd be very silly for an activist to come in and say double your dividend today or buy in a whole lot more stock or whatever it might be they would be proposing. I think the companies are well run and I think their financial policies are sound."

He added that when you have "a well-run company, the best thing to do is just to sit back and enjoy it."

Naturally, this doesn't mean ValueAct won't ultimately end up having a positive effect.

They just may.

We'll see in due time what kind of activist role, if any, they intend to play.

More in a follow-up.


Long position in AXP established at much lower than recent prices

Related posts:
Activists & the AmEx buyback, Part II (follow-up)
Altria: Price Matters
Multiple Expansion, Buybacks, & The P/E Illusion
The P/E Illusion
The Benefits of a Declining Stock
Buffett's Purchase of IBM Revisited
Buffett on Buybacks, Book Value, and Intrinsic Value
Buffett on Teledyne's Henry Singleton
Why Buffett Wants IBM's Shares "To Languish"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?

* Some might argue the long-term owner could simply sell and either wait for a better price to buy again or invest elsewhere. That approach sounds better in theory than it is in practice. When shares sell at a substantial premium to value or, for example, when opportunity costs are high there are times selling will be warranted. Yet, at least for me, this kind of behavior can be a recipe for unnecessary mistakes. There's usually a limit to the number of businesses one can understand well. Better to own some good businesses -- at least those bought at a discount and understood well -- for a very long time. Minimize frictional costs; minimize mistakes.
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, August 4, 2015

What's Gold Intrinsically Worth?

For roughly a decade, starting in 2001, gold prices performed extremely well.

So fans of the yellow stuff will rightly point to that fact.

I'll say upfront that I have just about zero interest in owning gold or any other nonproductive asset. Yet I'm certainly familiar with some of the arguments that are made for owning gold. As is often the case, Jim Grant is thoughtful on the subject of gold (and many other things related to finance and financial history) and worth paying attention to whether or not you happen to agree with him.

Grant points out that the dollar -- and this clearly applies to other paper currencies -- has "no intrinsic value" and is "faith-based."

Can't really argue with that but I think Jeremy Grantham makes a fair point when he says:

"...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."

Grant does, in fact, think it makes sense to own gold recently calling it "an investment in financial and monetary disorder."

He also makes his case for a return to the gold standard.

"...the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

For Grant, that'd be a monetary system directly linked to the quantity of gold that can be dug up over time.

Those who share these views (and similar ones) may even prove to be right.

I certainly agree that a paper currency, even under the very best of circumstances, is likely -- if not certain -- to diminish in value over the longer haul. Inflation of some kind or another should erode the purchasing power of just about any currency over time whether or not there is a full-blown currency crisis.

The question is what to do about it.

I think that Grantham has it essentially just about right:

"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."

For me, the problem has been and remains estimating what gold is intrinsically worth.

Unlike a high quality business it doesn't produce any cash.

Gold's value is perceived, or maybe relative, but it's not intrinsic.

Jason Zweig explains it this way:

" will put lightning in a bottle before you figure out what gold is really worth."

WSJ: Let's Be Honest About Gold: It's a Pet Rock

Without a stream of free cash flow how can what something is intrinsically worth, if anything, be known within a narrow enough range?

Warren Buffett, much like Grantham, also suggests that productive assets* are the way to go: "Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor" to buy something like their favorite soda or candy.

Investing in a productive asset is very different than attempting to guess what someone else will be willing to pay for a lump of metal down the road. Here's what Buffett once said on CNBC:

" is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something you expect to produce income for you over time."

Some may know (or think they know) where the price of gold is headed.

I have no idea and never will.

In fact, I'll never spend a moment trying to guess such a thing.

Zweig writes the following about those who are the truest believers -- the so-called "gold bugs" -- in the wisdom of gold ownership.

"Recognize...that gold bugs...often resemble the subjects of a laboratory experiment on the psychology of cognitive dissonance.

When you are in the grip of cognitive dissonance, anything that could be regarded as evidence that you might be wrong becomes proof that you must be right."

He then added this line:

"You don't want to be one of these people, spending years telling reality that it is wrong."

Zweig's article shows that for the past forty years or so the faith-based yellow metal has not generated much in terms or relative or absolute returns:

Avg Annual Return Since 1975 (after inflation)
- Gold: 0.8%
- Bonds: 5.0% ,
- Stocks: 8.3%
- Cash: 1.1%

Maybe the future will prove very different.

Personally, I'd be surprised if stocks or bonds do nearly as well going forward considering current valuations especially if (when?) interest rates normalize.


No idea.

Few asset categories, broadly speaking, are plainly inexpensive though there's almost always some individual investment that's selling at a discount for situation specific reasons.
(The tough part being to find one you understand well enough to invest.)

Charlie Munger is, to say the least, usually rather forthright and has a unique way of getting to the point. Well, here's how he looks at gold:

"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."

And one final thought on gold from Jeremy Grantham...

"I hate gold. It does not pay a dividend, it has no value, and you can't work out what it should or shouldn't be worth...It is the last refuge of the desperate."

Of course, for all I know, gold will do very well in the future.

This is irrelevant for me since I have no way of valuing it.

For me it's simple:

If I don't know how to value something, I shouldn't own it.


Related posts:
-Buffett & Munger on Gold
-Buffett on Productive Assets
-Buffett: Why Stocks Beat Gold
-Buffett: Why Stocks Beat Bonds
-Buffett on Gold, Farms, and Businesses
-Edison on Gold: Fictitious Value & Superstition
-Munger on Buying Gold
-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

* Examples of what Buffett calls productive assets:
    - Businesses (incl. partial ownership of businesses via marketable stocks)
    - Farms
    - Real Estate

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.