Tuesday, October 27, 2015

Buffett on Food Company Valuations

Earlier this year, Berkshire Hathaway (BRKa) and 3G Capital put togehter a large deal for what is now Kraft Heinz (KHC). Warren Buffett, after making some specific comments back in August about Kraft Heinz on CNBC, offered a more generalized view of larger food company market valuations.

He said that "most of the food companies sell at prices that it would be very hard for us to make a deal..."

This at least suggests future stock returns might be a whole lot less attractive if the existing price environment persists. In fact, those who likes one or more of these businesses as an investment for the longer haul (i.e. not as a speculative trade) should prefer that their shares underperform in the coming years.*

So, even if these businesses do perform reasonably well, equity return expectations should be tempered due to the fact that market prices aren't, in general, selling at a discount to per share intrinsic value.
(In fact, some to me now appear to be selling at a premium to value.)

The equity valuation environment was entirely a different one several years ago. Some of the consumer packaged goods makers remain terrific businesses in my view but, no matter how high quality something is, price matters.

Even the very best of these types of businesses certainly have not risen, on a per share basis, intrinsically in value as much as their stock prices have risen in recent years.
(Though some were selling at a nice discount to value back then so some of the gains since that time can be partly explained by having closed -- or more than closed -- that gap.)

It's when fear begins to dominate the psychology of markets that usually spells opportunity. Even very good businesses are far from immune to negative market price action.

That is -- or, at least, should be viewed as -- the good news.

"Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down." - Warren Buffett in his 1992 Berkshire Hathaway Shareholder Letter

Attractive prices rarely come along when the outlook is rosy. Most of the time -- short of a broad-based market decline -- there will be real and/or perceived legitimate questions about future prospects.**

A temporary, or even extended, drop in price can prove beneficial for investors.

A permanent drop in value is not.

High quality businesses tend to have durable advantages that allow intrinsic values to be persistent even in challenging economic environments while generally increasing -- even if unevenly -- over the longer haul.

Attempting to judge how intrinsic values might change and whether the price paid offers sufficient margin of safety ought to take priority over attempting to guess where prices are going near-term (or even intermediate-term).

Will these businesses still be able to deliver the kind of results they've been producing for a very long time?

A more challenging future doesn't necessarily mean the best of these have become -- or will become -- subpar businesses, but questions like this (and many others) still need to be carefully considered.

The world they're competing in is, as it likely always will be, changing in ways that might alter what have in the past been attractive core business economics.

Adam

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

* To not only allow for the purchase/accumulation of more shares, but also so buybacks and dividend reinvestments are more effective. Some might wonder why Buffett wouldn't just sell now that market prices more fully reflect value. Well, he's made it clear they're in it for the long haul -- they're in it for what the business will be able to produce over a very long time horizon. So, in other words, he's likely satisfied with the price he paid against current value and the value that will be created over time. That doesn't mean current market prices make much sense.
** Few businesses, if any, are immune to difficulties from time to time. Part of investing well is learning how to differentiate the temporary but fixable setbacks from those that are more fundamental and value destroying in a permanent way.
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