Monday, April 1, 2019

Buffett on Expenses: Calling a Dog's Tail a Leg Doesn't Make it One

From Warren Buffett's latest letter:

"...managements sometimes assert that their company's stock-based compensation shouldn't be counted as an expense. (What else could it be – a gift from shareholders?) And restructuring expenses? Well, maybe last year's exact rearrangement won't recur. But restructurings of one sort or another are common in business – Berkshire has gone down that road dozens of times, and our shareholders have always borne the costs of doing so.

Abraham Lincoln once posed the question: 'If you call a dog's tail a leg, how many legs does it have?' and then answered his own query: 'Four, because calling a tail a leg doesn't make it one.' Abe would have felt lonely on Wall Street.

Charlie and I do contend that our acquisition-related amortization expenses of $1.4 billion...are not a true economic cost. We add back such amortization 'costs' to GAAP earnings when we are evaluating both private businesses and marketable stocks.

In contrast, Berkshire's $8.4 billion depreciation charge understates our true economic cost. In fact, we need to spend more than this sum annually to simply remain competitive in our many operations. Beyond those 'maintenance' capital expenditures, we spend large sums in pursuit of growth. Overall, Berkshire invested a record $14.5 billion last year in plant, equipment and other fixed assets, with 89% of that spent in America.

The practice of ignoring real costs like stock-based compensation is the practice of deliberately making what's inherently challenging -- the investing process -- even more so.

Unfortunately it remains a not uncommon practice especially for businesses that rely heavily upon stock-based compensation.

Those who use earnings per share (reported or estimated) that exclude these real costs as a basis for calculating intrinsic value end up, all else equal, with an inflated assessment that value.

This conscious distortion may be a great way to feel better in the near term but it's an even better way to transfer wealth to strangers (the exiting shareholders) while, as a bonus I guess, taking on additional risk that need not be taken.

Now it's possible that, because a particular business has rapidly improving prospects, such a "gift" may be masked by the rapid increase to intrinsic business value. Yet the "gift" is still real even if buried inside the bigger story. It seems rather obvious that a more wise approach would be to admit a higher premium is being paid -- and in some cases no doubt a justifiable premium -- than to pretend the current earnings are higher than reality.

Premium prices built upon inflated earnings can, in fact, function as a gift to exiting shareholders.

Nothing wrong with generosity but I think it's fair to say there's better ways to go about being charitable.

Attempting to understand why what should be relatively informed individuals -- investors, analysts, and managements -- would accept such an alternative reality is worth the effort. There are, of course, underlying social and psychological factors at work here.

Those factors may not always be obvious or measurable but they're real and potent.

Adam

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.

Friday, February 15, 2019

Berkshire Hathaway 4th Quarter 2018 13F-HR

The Berkshire Hathaway (BRKa4th Quarter 13F-HR was recently released. 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 3rd Quarter 13F-HR.)

There was both some buying and selling during the quarter. Here's a quick summary of the changes:*

New Positions
Red Hat (RHT)
Suncor (SU)
StoneCo (STNE)

Added to Existing Positions
Bank of America (BAC)
US Bancorp (USB)
JP Morgan Chase (JPM)
Bank of NY Mellon (BK)
General Motors (GM)
PNC Financial (PNC)
Travelers (TRV)

Reduced Positions
Apple (AAPL)
Wells Fargo (WFC)
Southwest (LUV)
Charter (CHTR)
United Continental (UAL)
Phillips 66 (PSX)

Berkshire previously announced they may need to sell some of their Wells Fargo shares from time to time to keep the ownership stake below 10%.

Sold Positions
Oracle (ORCL)

Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.

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.

Also, Todd Combs and Ted Weschler are responsible for part of the Berkshire equity portfolio. So some of the changes -- especially those involving smaller positions -- will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire's portfolio of equity securities remains mostly made up of financial, consumer, and technology stocks (mostly Apple).**

1. Apple (AAPL) = $ 39.4 bil.
2. Bank of America (BAC) = $ 22.1 bil.
3. Wells Fargo (WFC) = $ 19.7 bil.
4. Coca-Cola (KO) = $ 18.9 bil.
5. American Express (AXP) = $  14.5 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 also 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 ~ 377,000 employees (26 at headquarters) according to the latest available annual report.

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, Berkshire Hathaway Automotive, Oriental Trading Company, Precision Castparts, and Duracell.
(Among others.)

In addition to the above businesses and investment portfolio, Berkshire's large insurance operation (BH Reinsurance, General Re, GEICO etc.) has historically been rather profitable while providing plenty of "float" for their investments.

Page A-1, near the end of the annual report, has a complete listing of Berkshire's businesses.

Adam

Long positions in BRKb, AAPL, AXP, USB, WFC, BAC, and JPM established at much lower than recent market prices. (In each case compared to average cost basis.)

* 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. Also, certain equity holdings are reported separately -- in some cases contributing to a mismatch between what's reported in the annual letter and the end of year 13F -- while investments in things like preferred shares and warrants, when applicable, are not included.
** All values shown are based upon the last trading day of the 4th quarter.
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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.

Thursday, January 17, 2019

John "Jack" Bogle

...will be missed.

Warren Buffett once explained the significance of Jack Bogle's contribution this way:

"If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.

In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me."

Separately, in a tribute to Mr. Bogle, Buffett also said:

"Jack Bogle has probably done more for the American investor than any man in the country. (Applause)

And Jack, would you stand up? There he is." (Applause)

"I estimate that Jack, at a minimum, has saved — left in the pockets of investors, without hurting them overall in terms of performance at all — gross performance — he's put tens and tens and tens of billions into their pockets. And those numbers are going to be hundreds and hundreds of billions over time."

Fortunately, Jack Bogle's wisdom remains available to all in the form of the many interviews, articles, and books he has written over the years.

Adam

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, January 9, 2019

Quotes of 2018

Here's a collection of quotes said or written at some point during 2018.

Warren Buffett: When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
"...I would prefer to turn immediately to discussing Berkshire's operations. But...I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.

The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire's 'bottom-line' will be useless.

The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.

That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse)." - Warren Buffett


Jeff Bezos on High Standards
"High standards are contagious. Bring a new person onto a high standards team, and they'll quickly adapt. The opposite is also true. If low standards prevail, those too will quickly spread...I believe high standards are domain specific, and that you have to learn high standards separately in every arena of interest. When I started Amazon, I had high standards on inventing, on customer care, and (thankfully) on hiring. But I didn't have high standards on operational process: how to keep fixed problems fixed, how to eliminate defects at the root, how to inspect processes, and much more. I had to learn and develop high standards on all of that (my colleagues were my tutors).

Understanding this point is important because it keeps you humble. You can consider yourself a person of high standards in general and still have debilitating blind spots. There can be whole arenas of endeavor where you may not even know that your standards are low or non-existent, and certainly not world class. It's critical to be open to that likelihood." - Jeff Bezos

Berkshire 2018 Meeting Highlights - Part II
"...I have here a New York Times of March 12th, 1942. I'm a little behind on my reading. (Laughter)

And if you go back to that time, that — it was about, what? Just about three months since we got involved in a war which we were losing at that point.

The newspaper headlines were filled with bad news from the Pacific...I'd like you to imagine that at that time you had invested $10,000And you put that money in an index fund — we didn't have index funds then — but you, in effect, bought the S&P 500...[or]...Let's say you'd taken that $10,000 and you'd listened to the prophets of doom and gloom around you, and you'll get that constantly throughout your life. And instead, you'd used the $10,000 to buy gold...And you could look at it...But it didn't produce anything. It was never going to produce anything...So if you decided to go with a nonproductive asset — gold — instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock — whatever it might be — you would now have over 100 times the value of what you would have had with a nonproductive asset.

In other words, for every dollar you had made in American business, you'd have less than a penny by — of gain — by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort." - Warren Buffett

"...the one thing we know is we think that long-term bonds are a terrible investment, and we — at current rates or anything close to current rates...it's almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you're an individual, then you pay tax on it. You're going to have some income taxes to pay.

And let's say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income...I think I would stick with productive businesses, or productive — certain other productive assets — by far.

But what the bond market does in the next year, you know — you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge. - Warren Buffett

"...it really wasn't fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.

But it clearly wasn't fair. And the conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time...And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people..." - Charlie Munger

Happy New Year,

Adam

Quotes of 2017 
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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.