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.
---
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, October 12, 2015

Activists & the AmEx Buyback, Part II

A follow up to this post. Last month news broke that an activist hedge fund, ValueAct Capital Management, had taken a stake in American Express (AXP).

Well, not long after the ValueAct stake was announced, Warren Buffett had the following to say about buybacks and AmEx in an interview on CNBC:*

"People assume when we buy some stock we want it to go up. We don't want it to go up. Maybe, obviously, eventually... five or ten years from now [we'd like it]."

He added "we love the idea" of a business with an already cheap stock "buying its stock cheaper. I mean that's happened at American Express", and since they're "a regular repurchaser of shares", Berkshire Hathaway's (BRKa) stake increases more quickly "if the stock is down than if the stock is up."

Buffett was then asked whether he likes to see an activist like ValueAct come into the picture with AmEx.

Buffett's response was "No not particularly but...it is up to them what they do with their money. Actually it [sent the stock up] four or five points so the extent that American Express is repurchasing shares" it actually hurts AmEx long-term shareholders. He also said that "the cheaper the stock is the more shares American Express will be able to repurchase for a given amount of money and on balance...that helps us."

Each dollar used to buyback shares will have a smaller impact on share count. Plainly not a good thing for the long-term owner.

Fortunately the stock has come back down somewhat since Buffett said the above -- in part due to some of the market turmoil -- but, then again, maybe it would be down even more if there was no activist involvement.

The problem here is not at all specific to ValueAct. As I wrote in the prior post:

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

They just may.

It's just that whatever effect on the business they end up having, it will potentially have to offset the negative impact -- at least from the standpoint of a long-term investor in AmEx -- of the higher prices making the buyback activity less effective (if the higher stock price proves persistent and is directly related to the hope an activist will eventually have a favorable influence).

Now, whether or not AmEx must adapt more effectively to a changing competitive and technological landscape is an important and fair debate. If an investor comes along -- one who's in it for the long haul -- can contribute to such a debate that certainly wouldn't be the worst thing that could happen.

More from last week's interview with Buffett:

"...People make buybacks very complicated. [A buyback] makes sense when you are buying your stock back below its intrinsic value and when you don't need that money for the needs of the business. And it makes no sense when you pay above intrinsic value and that's a very simple principle but it has been ignored by many managements over time."

I know it might seem odd to think of a stock rallying as bad news but, if a good business with some extra cash is buying back shares that sell nicely below per share intrinsic value, that's simply how the math works -- especially in the long run. Depending on for how long, and by how much, the stock remains below intrinsic the effect on future per share intrinsic value can be anywhere from negligible to quite substantial.

The reality is it makes little sense, no matter how counterintuitive, to hope shares of a good business rally in the near-term when the plan is to be an owner for decades. Of course, this won't work if the enterprise proves fundamentally flawed in some way. Otherwise, for those in a position to consistently buyback shares over time any near-term (or even intermediate-term) rally will only reduce returns. In other words, a stock that sells persistently below what it's intrinsically worth can increase investor returns, all else equal, at less risk.**

Naturally, for those who plan to sell next week it's a very different story.

During the interview Buffett points out that he can't buy more shares of AmEx. 

The reason? 

AmEx is a bank holding company and Berkshire already owns as much as is allowed.

Adam

Long position in AXP and BRKb established at much lower than recent prices

Related posts:
Activists & the AmEx Buyback, Part I
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?

* These quotes, in some cases, differ very slightly from CNBC's unofficial transcript.
** This can, depending on the circumstances, also work for dividend reinvestments.

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.
 
Site Meter