Friday, April 1, 2016

Flying Too Close To The Sun

Warren Buffett, in last year's Berkshire Hathaway (BRKaspecial letter*, explained that conglomerates have been at times very popular but became especially so back in the 1960s:

"Since I entered the business world, conglomerates have enjoyed several periods of extreme popularity, the silliest of which occurred in the late 1960s."

This was covered, to an extent, in a post from late last year.

LTV -- a company once run by Jimmy Ling during that era -- is used as an example of a conglomerate structure that goes very wrong. From the letter:

"Through a lot of corporate razzle-dazzle, Ling had taken LTV from sales of only $36 million in 1965 to number 14 on the Fortune 500 list just two years later. Ling, it should be noted, had never displayed any managerial skills. But Charlie told me long ago to never underestimate the man who overestimates himself. And Ling had no peer in that respect.

Ling's strategy...was to buy a large company and then partially spin off its various divisions. In LTV’s 1966 annual report, he explained the magic that would follow: 'Most importantly, acquisitions must meet the test of the 2 plus 2 equals 5 (or 6) formula.' The press, the public and Wall Street loved this sort of talk.

In 1967 Ling bought Wilson & Co., a huge meatpacker that also had interests in golf equipment and pharmaceuticals. Soon after, he split the parent into three businesses, Wilson & Co. (meatpacking), Wilson Sporting Goods and Wilson Pharmaceuticals, each of which was to be partially spun off. These companies quickly became known on Wall Street as Meatball, Golf Ball and Goof Ball.

Soon thereafter, it became clear that, like Icarus, Ling had flown too close to the sun. By the early 1970s, Ling's empire was melting, and he himself had been spun off from LTV . . . that is, fired.

Periodically, financial markets will become divorced from reality – you can count on that. More Jimmy Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will fight for their business. What they are saying will recently have 'worked.' Their early followers will be feeling very clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is --- zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices."

So a bit of healthy skepticism comes in handy when some repackaged business strategy is being promoted aggressively (especially when bankers and the press fan the flames). This is especially true when questionable accounting and aggressive financing comes into play.

CEO behavior can have a huge impact on intrinsic business value especially over the very long haul. The good news is that plenty of extremely capable business executives are out there. Unfortunately, personality and salesmanship sometimes get in the way of making a sound judgment about a CEOs overall talents. For investors, it's vital to I.D. situations beforehand that lead to inflated perceived prospects and, at least for a time, a valuation that reflects the flawed perception.

The specifics may vary but it almost always is wise to avoid of investing in -- or, at times, alongside -- those who tend to overestimate themselves no matter how smart someone is (or seems to be).

"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger speech to the Foundation Financial Officers Group

"We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them." - Charlie Munger at the 2007 Berkshire Hathaway Shareholder Meeting

"If you think your IQ is 160 but it's 150, you're a disaster. It's much better to have a 130 IQ and think it's 120." - Charlie Munger at the 2009 Berkshire Hathaway Shareholder Meeting

"If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's most important is inner peace; you have to be able to think for yourself. It's not a complicated game." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting

Humility and knowing what you don't know can go a long way in investing.

Adam

Long position in BRKb established at much lower than recent market prices

Related posts:
Berkshire's Structure: Why It Works
Corporate Hocus-Pocus
Charlie Munger: Focus Investing and Fuzzy Concepts
Grantham & Buffett: "Career Risk" & "The Institutional Imperative"
Buffett on "The Institutional Imperative"
Buffett: A Portrait of Business Discipline
Buffett on Bold & Imaginative Accounting
Charlie Munger on LTCM & Overconfidence
When Genius Failed...Again

* This is Buffett's special letter that was written for the 50th Anniversary of Berkshire. Munger also wrote a separate letter to recognize this Golden Anniversary. These can also be found at the end of the regular letter (page 24 and 39 respectively).
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