From Warren Buffett's 1995 Berkshire Hathaway (BRKa) shareholder letter:
...sellers and their representatives invariably present financial projections having more entertainment value than educational value. In the production of rosy scenarios, Wall Street can hold its own against Washington.
In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead keep in mind the story of the man with an ailing horse. Visiting the vet, he said: "Can you help me? Sometimes my horse walks just fine and sometimes he limps." The vet's reply was pointed: "No problem - when he's walking fine, sell him." In the world of mergers and acquisitions, that horse would be peddled as Secretariat.
A business run by management in the habit of paying Secretariat prices for so-called strategic acquisitions is a sell.
In most cases, that so-called strategic deal is just a cloak around the reality that a wealth transfer from acquirer to acquiree shareholders is taking place. A company with entrenched management that behaves this way materially reduces the growth in intrinsic value of a business (in fact may shrink it) and, of course, shareholder wealth.
Imagine Berkshire Hathaway without all the smart deals done over the years. Intrinsic value today would be an awful lot less.
Any use of the words like strategic or synergistic to justify a deal warrants skepticism. Consider those words as code for "we are getting bigger at shareholder expense". When these terms are employed, it's almost guaranteed that management overpaid and is selling the rich price to shareholders on the basis of some mysterious hidden value. The likely reality is that animal spirits kicked in during the acquisition process and management began buying the kind of "rosy scenarios" that Buffett refers to above.
So the pitch to shareholders on the merits of the deal will often be under the guise that value not yet revealed will, out of thin air, somehow emerge. Naturally, once the deal is done if that value does not appear down the road there is no recourse. The wealth transfer will have happened with acquiring shareholders feeling (in fact being) a bit poorer.
The bottom line is that management should, in most cases, pay only for the proven economics of a business...not promise.
If not a rule it's the next best thing.
The intrinsic value of a business is raised by having a management team in place that consistently makes smart acquisitions at fair, or better yet, limping horse prices.
Adam
Long BRKb
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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 are never a recommendation to buy or sell anything.
Thursday, June 16, 2011
Wednesday, June 15, 2011
In Praise of Two Troubled Sectors
Here's a recent Barron's Magazine interview with David Katz of Matrix Asset Advisors.
In it, he says financials have the potential to rise 30-50% in the next year or two.
He also point out how cheap larger tech stocks happen to be.
A long and growing list of value-oriented investors have pointed out that financials and technology are inexpensive and I happen to agree with it.
I've highlighted tech stocks as being inexpensive for quite a while.
As stocks they are going nowhere fast and I won't be surprised if that continues.
Bank stocks have also done poorly for an extended period. That's also likely to continue.
"The last time I was heavily involved with the banks, it was a five-to-ten-year period. And I'm always early, which in a way is a good thing because if you were right on day one, you'd have a much smaller position." - Bruce Berkowitz of Fairholme in Institutional Investor Magazine
With value investing, even if you get something right in the long run (defined as above market returns over the entire investment horizon that the asset is held), you'll probably be staring at red for a very long time.
"...if you are a value manager, you buy cheap assets. If you are very 'experienced,' a euphemism for having suffered many setbacks, you try hard to reserve your big bets for when assets are very cheap. But even then, unless you are incredibly lucky, you will run into extraordinarily cheap, even bizarrely cheap, assets from time to time, and when that happens you will have owned them for quite a while already and will be dripping in red ink." - Jeremy Grantham from his letter with the title: Time To Be Serious (and probably too early) Once Again
That's why I don't think someone should buy something that seems inexpensive, unless that investor has extraordinary personal conviction that the price paid provides a sufficient discount to their own conservative estimate of intrinsic value. That's also why I don't think it's wise to buy something unless it's based upon one's own analysis and conclusions. I happen to think no investor should buy something based upon someone else's opinion. Read everything possible, listen to lots of viewpoints, but reach your own conclusions. When an investor does not have high levels of conviction at their disposal, they end up shaken out before the full story plays out, in some cases, over many years.
So the norm is to be too early because an investment looks cheap not knowing that it will, at first, get even cheaper.
In a similar way, selling an investment too early also tends to happen when something starts to look expensive (only to watch it become more expensive).
It goes with the territory of making buy and sell decisions that are grounded by valuation.
"I made my money by selling too soon." - Bernard Baruch
An asset that is already cheap becoming even cheaper is just the flip side of what happened during some of our recent bubbles. Expensive stocks got even more expensive before ultimately being checked by economic reality. The forces that cause bizarre prices in either direction begin with either a real problem or real potential taken to extreme. Never expect rationality when it comes to short-to-intermediate run market prices.
The remaining true believers of efficient market hypothesis won't care much for this thinking. In the short-to-intermediate run a market price has only a loose connection to the value of a business itself.
I think the evidence in support of this view is overwhelming.
There are many short-to-intermediate term events that move a stock price in any direction that has little to do with what the intrinsic value of an asset will be over the long haul.
When volatile short-term price movements morph into persistent downward selling pressure many, especially those lacking conviction in what the asset is ultimately worth, will just bail out.
Financials stocks, in particular, are probably not the place to be for those seeking a straightforward investment (I'm not sure there is such a thing, but, for example, a proven consumer staple franchise is certainly less tricky to own than a bank). Many things can go wrong with even a good bank that is beyond management control. As we've seen recently, confidence in and stability of the financial system as a whole is bigger than any one bank and can dramatically impact future intrinsic value per share.
There will likely be many twists and turns before things like the regulatory, legal, and mortgage clouds are put mostly in the rear-view mirror for financials. Future regulatory risks are especially difficult to predict.
(I say that as someone who wants further limits on speculation by banks, far beyond the so-called Volcker Rule, substantially reduced use of derivatives, and significant changes to bank executive compensation systems so leaders of the key financial institutions have more skin in the game...more to lose longer term.)
The problem? It's just as likely that poorly focused regulatory over-reach will occur that just adds complexity and costs but does little to address those things that lead to systemic instability (many didn't listen to Brooksley Born in the 1990s and I'm not sure we making enough wise moves now).
Still, the highest quality financials over ten year horizon should do just fine even if the ride will likely be very bumpy. There are many difficult to understand risks in the short-to-intermediate term. During that time, again, I'd expect many investors to just get tired of all the noise and for prices to go nowhere. There are easier ways to get results.
As far as technology stocks go, many larger tech stocks have been cheap for quite a while yet continue to get even cheaper. Who knows how long this persists. Unlike financials, it would seem the biggest risks are unknowable technology shifts and new competitors that out of nowhere threaten the economic moat of a franchise.
That's the nature of tech.
How long do these two sectors struggle? In my experience it is always longer than one expects. Long enough for most who have had their money tied up in a dead money stock (or worse) for a long time to get frustrated, annoyed, and just sell.
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.
In it, he says financials have the potential to rise 30-50% in the next year or two.
He also point out how cheap larger tech stocks happen to be.
A long and growing list of value-oriented investors have pointed out that financials and technology are inexpensive and I happen to agree with it.
I've highlighted tech stocks as being inexpensive for quite a while.
As stocks they are going nowhere fast and I won't be surprised if that continues.
Bank stocks have also done poorly for an extended period. That's also likely to continue.
"The last time I was heavily involved with the banks, it was a five-to-ten-year period. And I'm always early, which in a way is a good thing because if you were right on day one, you'd have a much smaller position." - Bruce Berkowitz of Fairholme in Institutional Investor Magazine
With value investing, even if you get something right in the long run (defined as above market returns over the entire investment horizon that the asset is held), you'll probably be staring at red for a very long time.
"...if you are a value manager, you buy cheap assets. If you are very 'experienced,' a euphemism for having suffered many setbacks, you try hard to reserve your big bets for when assets are very cheap. But even then, unless you are incredibly lucky, you will run into extraordinarily cheap, even bizarrely cheap, assets from time to time, and when that happens you will have owned them for quite a while already and will be dripping in red ink." - Jeremy Grantham from his letter with the title: Time To Be Serious (and probably too early) Once Again
That's why I don't think someone should buy something that seems inexpensive, unless that investor has extraordinary personal conviction that the price paid provides a sufficient discount to their own conservative estimate of intrinsic value. That's also why I don't think it's wise to buy something unless it's based upon one's own analysis and conclusions. I happen to think no investor should buy something based upon someone else's opinion. Read everything possible, listen to lots of viewpoints, but reach your own conclusions. When an investor does not have high levels of conviction at their disposal, they end up shaken out before the full story plays out, in some cases, over many years.
So the norm is to be too early because an investment looks cheap not knowing that it will, at first, get even cheaper.
In a similar way, selling an investment too early also tends to happen when something starts to look expensive (only to watch it become more expensive).
It goes with the territory of making buy and sell decisions that are grounded by valuation.
"I made my money by selling too soon." - Bernard Baruch
An asset that is already cheap becoming even cheaper is just the flip side of what happened during some of our recent bubbles. Expensive stocks got even more expensive before ultimately being checked by economic reality. The forces that cause bizarre prices in either direction begin with either a real problem or real potential taken to extreme. Never expect rationality when it comes to short-to-intermediate run market prices.
The remaining true believers of efficient market hypothesis won't care much for this thinking. In the short-to-intermediate run a market price has only a loose connection to the value of a business itself.
I think the evidence in support of this view is overwhelming.
There are many short-to-intermediate term events that move a stock price in any direction that has little to do with what the intrinsic value of an asset will be over the long haul.
When volatile short-term price movements morph into persistent downward selling pressure many, especially those lacking conviction in what the asset is ultimately worth, will just bail out.
Financials stocks, in particular, are probably not the place to be for those seeking a straightforward investment (I'm not sure there is such a thing, but, for example, a proven consumer staple franchise is certainly less tricky to own than a bank). Many things can go wrong with even a good bank that is beyond management control. As we've seen recently, confidence in and stability of the financial system as a whole is bigger than any one bank and can dramatically impact future intrinsic value per share.
There will likely be many twists and turns before things like the regulatory, legal, and mortgage clouds are put mostly in the rear-view mirror for financials. Future regulatory risks are especially difficult to predict.
(I say that as someone who wants further limits on speculation by banks, far beyond the so-called Volcker Rule, substantially reduced use of derivatives, and significant changes to bank executive compensation systems so leaders of the key financial institutions have more skin in the game...more to lose longer term.)
The problem? It's just as likely that poorly focused regulatory over-reach will occur that just adds complexity and costs but does little to address those things that lead to systemic instability (many didn't listen to Brooksley Born in the 1990s and I'm not sure we making enough wise moves now).
Still, the highest quality financials over ten year horizon should do just fine even if the ride will likely be very bumpy. There are many difficult to understand risks in the short-to-intermediate term. During that time, again, I'd expect many investors to just get tired of all the noise and for prices to go nowhere. There are easier ways to get results.
As far as technology stocks go, many larger tech stocks have been cheap for quite a while yet continue to get even cheaper. Who knows how long this persists. Unlike financials, it would seem the biggest risks are unknowable technology shifts and new competitors that out of nowhere threaten the economic moat of a franchise.
That's the nature of tech.
How long do these two sectors struggle? In my experience it is always longer than one expects. Long enough for most who have had their money tied up in a dead money stock (or worse) for a long time to get frustrated, annoyed, and just sell.
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.
Tuesday, June 14, 2011
Tweedy, Browne: Strong Consumer Brands for the Emerging Middle Class
Some excerpts from the Tweedy, Browne Annual Shareholder Letter.
The letter highlights companies like: Diageo (DEO), Unilever (UL), Philip Morris International (PM), Kimberly Clark (KMB), Nestle (NSRGY), Heineken (HINKY) and Novartis (NVS) and others.
...our Funds' portfolios today include many large, globally diversified companies, many of them branded consumer products companies, that conduct a considerable amount of business in faster growing parts of the globe where a new middle class is emerging. These are companies such as Nestle, Heineken, Diageo, Unilever, Philip Morris International, Kimberly Clark, Henkel, and Novartis, among others. While our interest in these businesses wasn't predicated on this idea of a rising middle class, but rather from the fact that these businesses were attractively valued at various points in time, their strong consumer brands and global operating experience gives these companies a leg up when competing for this new and rapidly growing source of demand.
In the letter, some important shifts that are likely to occur over the next 5 to 10 years are highlighted:
...by 2015, for the first time in 300 years, the number of Asian middle class consumers will equal the number in Europe and North America.
It also points out that it is very likely over the next ten years for Europe and North America's nearly 1 billion combined middle class consumers will remain essentially flat. In contrast to that, Asia Pacific's one half billion middle class consumers should easily triple in size.
Consumption in Asia Pacific, around $ 5 trillion already (nearly the same size as North America alone), is expected to roughly triple over the next decade.
Some comments were made on specific stocks that benefit.
Here are two:
On Philip Morris International
Philip Morris International, another one of our holdings, is the world's leading international tobacco company, with seven of the world’s top fifteen international brands. Approximately 35% of company profits derive from the emerging markets. In the 4th quarter of 2010, it reported a 15% increase in profits driven largely by a 24% surge in volume in Asian markets such as Indonesia, the Philippines, and South Korea.
The letter points out that Philip Morris International is the only international tobacco company to strike a deal with the Chinese National Tobacco Corporation to sell the Marlboro brand. Philip Morris has a good prospects going forward even if nothing material happens in China. So I wouldn't count on China producing terrific economics for the company but consider it upside.
Philip Morris International has a great combination of assets and future prospects but the recent extremely cheap valuation of the shares is no longer there. Still, if bought and held for 20 years I'd be surprised if it did not produce good investor returns.
Historically, I've preferred accumulating shares in tobacco companies when legal clouds have been at or near their darkest. For me, any additional shares would likely be bought as a result of some new ugly headlines. For now the legal front is relatively quiet but you never know when that will change.
It was easier to buy at a discount when Altria (MO) owned Philip Morris International's assets. When it traded as one stock, it made the specific risks associated with the legal environment in the U.S. (those that directly impact the U.S. tobacco business) hurt the valuation of those assets that are now separately Philip Morris International.
On Diageo
Diageo, the world's leading spirits company, today derives about about one-third of its sales from the emerging markets, with much of that growth coming from China, where drinkers are consuming more and more Johnnie Walker Scotch and Guinness beer. Ivan Menezes, the company's President, North America and Chairman, Asia Pacific, expects that in just a few years, 50% of its business will originate in the emerging markets. An important factor in this growth has been "premiumizing" or the trading up to higher priced brands. Diageo has eight of the top twenty brands in spirits.
At its current size, Diageo is not the fastest growing spirits company but the economic moat that comes from its brands and distribution is significant. It's also an expensive stock. A short-term disappointment (sub-par growth, poor execution, the macro environment or something similar) in the future is probably going to be needed to make the stock sell at a more attractive level.
I understand some will not buy the so-called sin stocks for reasons that go beyond investing. For those preferring non-tobacco and non-alcohol related businesses in their portfolio, the other branded consumer companies noted in the Tweedy Browne letter have assets that should produce solid future returns (though I'd prefer Pepsi: PEP or Coca-Cola: KO at the right price).
The specific risks and opportunities of each, of course, do differ significantly but if bought at the right price most would make a worthwhile long-term core holdings in my view.
Adam
Long positions in DEO, PM, MO, PEP, and KO established at much lower prices
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.
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, June 13, 2011
Buffett on Microsoft
In this recent Reuters interview, Warren Buffett gave the following answer when asked about Microsoft (MSFT):
I regard myself as precluded from either personally or having Berkshire buy Microsoft because if something good happened the following week people would think Bill had told me. So I just see no way that we can ever buy Microsoft and be sure that we won't look like we had some kind of inside information or something. So it's off limits. It did look pretty cheap.
A somewhat surprising answer after years of just saying he avoids tech for the most part due to the nature of tech businesses themselves. Tech business that have an economic moat eventually have that moat threatened by some technology shift or new competition.
Suddenly, what seemed like a fantastic business is not. Buffett clearly has historically liked durable businesses residing in industry with little change going on. Obviously, that's rarely going to be found in technology.
Suddenly, what seemed like a fantastic business is not. Buffett clearly has historically liked durable businesses residing in industry with little change going on. Obviously, that's rarely going to be found in technology.
The above seems practically like an endorsement of Microsoft's stock coming from him.
Adam
Long position in MSFT
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.
Long position in MSFT
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, June 9, 2011
Buffett on Macro Forecasts: Berkshire Shareholder Letter Highlights
Warren Buffett wrote the following in the 1994 Berkshire Hathaway (BRKa) shareholder letter:
We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.
But, surprise - none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.
A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.
These comments by Buffett are worth considering the next time one of the many who are in the business of making macro forecasts opines on business news.
At the very least, remember it the next time someone confidently predicts what the macroeconomic future will be and then makes a specific investing strategy recommendation based upon it.
At the very least, remember it the next time someone confidently predicts what the macroeconomic future will be and then makes a specific investing strategy recommendation based upon it.
Adam
Long BRKb
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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 are never a recommendation to buy or sell anything.
Long BRKb
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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 are never a recommendation to buy or sell anything.
Jamie Dimon Challenges Bernanke
Jamie Dimon, the Chief Executive Officer of J.PMorgan Chase (JPM), had some things to say (in a public forum no less) about bank regulations to Ben Bernanke earlier this week. He's of the view regulators have gone too far and are slowing economic growth.
Bloomberg: Dimon Challenges Bernanke
It seems that some of the well-intentioned regulatory changes have lost focus. Dimon thinks overzealous regulation is hurting the economic rebound. He wonders whether in 20 years we'll look back on this time amd realize all the things we did to slow down the recovery.
What might be considered good examples of the lack of focus?
Considering the size of Dodd-Frank Act (well over 2000 pages in length), it's more than a little disappointing that so little has been done so far about the things that really got us into trouble. I mean, whether you think debit card swipe fee reform (part of Dodd-Frank) is fair or not it made no contribution to the crisis.
There is tons of complexity and uncertainty about what the new rules of the game will be. The rules have to be locked down if we want a more healthy expansion of credit to occur.
Much of what has been done appears to be potentially throttling the socially useful things that banks do.
A bank that provides credit to a sound business can help facilitate productive economic activity and growth.
A bank that funds a prop trading desk -- and things like it -- is of little to no value or worse.
The uncertainties created in this environment are holding both back. We need to lock down changes that will drive more of the former and less of the latter.
Adam
Long JPM
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.
Bloomberg: Dimon Challenges Bernanke
I'm sure some will see this just as a banker whining about the rules. I'm certainly someone who wants systemic risk reduced and the banks speculative activities reigned in.
I also happen to think it mostly needs to be done by separating or limiting short-term speculative trading activities financed with guaranteed money (other peoples money) and through the modification of bank executive compensation systems (bankers with more skin in the game...more negative consequences if they take dumb risks).
Ultimately, I'd prefer changes that encourage banks to focus on financing vital industries instead of financing prop trading desks focused on the short-term.
Ultimately, I'd prefer changes that encourage banks to focus on financing vital industries instead of financing prop trading desks focused on the short-term.
It seems that some of the well-intentioned regulatory changes have lost focus. Dimon thinks overzealous regulation is hurting the economic rebound. He wonders whether in 20 years we'll look back on this time amd realize all the things we did to slow down the recovery.
What might be considered good examples of the lack of focus?
Considering the size of Dodd-Frank Act (well over 2000 pages in length), it's more than a little disappointing that so little has been done so far about the things that really got us into trouble. I mean, whether you think debit card swipe fee reform (part of Dodd-Frank) is fair or not it made no contribution to the crisis.
Much of what has been done appears to be potentially throttling the socially useful things that banks do.
A bank that provides credit to a sound business can help facilitate productive economic activity and growth.
A bank that funds a prop trading desk -- and things like it -- is of little to no value or worse.
The uncertainties created in this environment are holding both back. We need to lock down changes that will drive more of the former and less of the latter.
Adam
Long JPM
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, June 8, 2011
Buffett on Coca-Cola: Berkshire Shareholder Letter Highlights
The excerpt below provides some historical perspective on Coca-Coca (KO).
As a major holding of Berkshire Hathaway (BRKa), Warren Buffett not surprisingly draws from the example of Coca-Cola but, from my perspective, what he says below applies to many other high qualiity franchises.
Which ones? Things like Pepsi: PEP, Heinz: HNZ, Diageo: DEO and Johnson & Johnson: JNJ come to mind among many others (i.e. brands consumed everyday with scale and broad distribution).
From the 1993 Berkshire Hathaway shareholder letter:
Let me add a lesson from history: Coke went public in 1919 at $40 per share. By the end of 1920 the market, coldly reevaluating Coke's future prospects, had battered the stock down by more than 50%, to $19.50. At yearend 1993, that single share, with dividends reinvested, was worth more than $2.1 million. As Ben Graham said: "In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine."
Later in the letter, Buffett highlights a Fortune article from 1938. The writer of the article implies that it was already too late, back in 1938, to benefit from the ownership of Coca-Cola's stock:
In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: "Several times every year a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him."
Yes, competition there was in 1938 and in 1993 as well. But it's worth noting that in 1938 The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.
Coca-Cola's potential to compound in value wasn't done in 1938 or 1993 and certainly isn't now. Though a large company, the economics that have propelled Coca-Cola's value upward aren't anywhere near exhausted.
Still, I'm guessing some will judge Coca-Cola's future propects beyond 2011 in a similar manner to that Fortune writer. That, once again, Coca-Cola is a great company with upside limited by sheer size and competition. Basically, that investors too late...again.
With the above in mind, consider how often layers of complexity and cost are added to the investing process when a perfectly sound and straightforward option is right there in front of you.
Below is an example (one of many) of how investing can be made more difficult and expensive than it otherwise needs to be. According to this Wall Street Journal article by Jason Zweig, an e-mail from Action Alerts PLUS, a trading tip service of Jim Cramer, claimed "My portfolio is CRUSHING the S&P 500..." and claims to have more than doubled the return of the S&P 500.
A bar graph showed the following performance comparison from January 1, 2002 to April 1:
S&P 500: 15.5% return
Mr. Cramer's Portfolio: 39.2% return
The above results apparently include dividends for Mr. Cramer's portfolio but does not include dividends for the S&P 500. The Wall Street Journal article says that the return of the S&P 500 with dividends was 38.3%.
So just a bit less than Mr.Cramer's portfolio.
Those returns are before trading costs, taxes, and the subscription fee ($ 299.95 for the first year) for the letter. The article points out that something like an average of 774 trades annually would be required.
774 trades? Yikes.
Let's do some math.
774 trades multiplied by a typical $ 7 per trade commission would cost an investor $ 5,418 per year.
So someone with a $ 100,000 portfolio would with $ 5,418 in commissions obviously be incurring more than 5% in frictional costs each year. Obviously, you'd need a much larger portfolio or lower trading costs so those costs don't substantially reduce total returns.
In fact, going back to 2002, a portfolio with 5% in annual commission costs easily wipes out (and then some) the 39.2% claimed total return. So the target audience for this service would have to be someone with much more money than $ 100k. Even so the math just doesn't work since that portfolio didn't even really outperform in the first place.
From the Wall Street Journal article:
...you could have bought and held an S&P 500 index fund and then done utterly nothing except reinvest your dividends. And you, too, would have more than doubled the market's return—calculated without dividends.
Alternatively, you could just steadily buy something like Coca-Cola (and a few of the other great franchises), whenever market prices seem reasonable*, and go beach.
If nothing else you'll save a whole lot on commissions.
Adam
Long all stocks mentioned except Heinz
* Coca-Cola and many other great consumer franchises became extremely expensive in the late 1990s. At that time they could not be bought at prices that would produce a satisfactory return. Market prices for these stocks were materially higher than intrinsic value. The past decade has mostly corrected this in my view.
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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 are never a recommendation to buy or sell anything.
As a major holding of Berkshire Hathaway (BRKa), Warren Buffett not surprisingly draws from the example of Coca-Cola but, from my perspective, what he says below applies to many other high qualiity franchises.
Which ones? Things like Pepsi: PEP, Heinz: HNZ, Diageo: DEO and Johnson & Johnson: JNJ come to mind among many others (i.e. brands consumed everyday with scale and broad distribution).
From the 1993 Berkshire Hathaway shareholder letter:
Let me add a lesson from history: Coke went public in 1919 at $40 per share. By the end of 1920 the market, coldly reevaluating Coke's future prospects, had battered the stock down by more than 50%, to $19.50. At yearend 1993, that single share, with dividends reinvested, was worth more than $2.1 million. As Ben Graham said: "In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine."
Later in the letter, Buffett highlights a Fortune article from 1938. The writer of the article implies that it was already too late, back in 1938, to benefit from the ownership of Coca-Cola's stock:
In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: "Several times every year a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him."
Yes, competition there was in 1938 and in 1993 as well. But it's worth noting that in 1938 The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.
Coca-Cola's potential to compound in value wasn't done in 1938 or 1993 and certainly isn't now. Though a large company, the economics that have propelled Coca-Cola's value upward aren't anywhere near exhausted.
Still, I'm guessing some will judge Coca-Cola's future propects beyond 2011 in a similar manner to that Fortune writer. That, once again, Coca-Cola is a great company with upside limited by sheer size and competition. Basically, that investors too late...again.
With the above in mind, consider how often layers of complexity and cost are added to the investing process when a perfectly sound and straightforward option is right there in front of you.
Below is an example (one of many) of how investing can be made more difficult and expensive than it otherwise needs to be. According to this Wall Street Journal article by Jason Zweig, an e-mail from Action Alerts PLUS, a trading tip service of Jim Cramer, claimed "My portfolio is CRUSHING the S&P 500..." and claims to have more than doubled the return of the S&P 500.
A bar graph showed the following performance comparison from January 1, 2002 to April 1:
S&P 500: 15.5% return
Mr. Cramer's Portfolio: 39.2% return
The above results apparently include dividends for Mr. Cramer's portfolio but does not include dividends for the S&P 500. The Wall Street Journal article says that the return of the S&P 500 with dividends was 38.3%.
So just a bit less than Mr.Cramer's portfolio.
Those returns are before trading costs, taxes, and the subscription fee ($ 299.95 for the first year) for the letter. The article points out that something like an average of 774 trades annually would be required.
774 trades? Yikes.
Let's do some math.
774 trades multiplied by a typical $ 7 per trade commission would cost an investor $ 5,418 per year.
So someone with a $ 100,000 portfolio would with $ 5,418 in commissions obviously be incurring more than 5% in frictional costs each year. Obviously, you'd need a much larger portfolio or lower trading costs so those costs don't substantially reduce total returns.
In fact, going back to 2002, a portfolio with 5% in annual commission costs easily wipes out (and then some) the 39.2% claimed total return. So the target audience for this service would have to be someone with much more money than $ 100k. Even so the math just doesn't work since that portfolio didn't even really outperform in the first place.
From the Wall Street Journal article:
...you could have bought and held an S&P 500 index fund and then done utterly nothing except reinvest your dividends. And you, too, would have more than doubled the market's return—calculated without dividends.
Alternatively, you could just steadily buy something like Coca-Cola (and a few of the other great franchises), whenever market prices seem reasonable*, and go beach.
If nothing else you'll save a whole lot on commissions.
Adam
Long all stocks mentioned except Heinz
* Coca-Cola and many other great consumer franchises became extremely expensive in the late 1990s. At that time they could not be bought at prices that would produce a satisfactory return. Market prices for these stocks were materially higher than intrinsic value. The past decade has mostly corrected this in my view.
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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 are never a recommendation to buy or sell anything.
Tuesday, June 7, 2011
Lowe's Shareholder-Friendly Buyback Plan
Shares in Home Depot (HD) and Lowe's (LOW) are, respectively, selling at 15x and 14x current year earnings.
That's not exactly expensive but other retailers, the likes of Wal-Mart (WMT) and Target (TGT), are even cheaper selling at more like 11.5-12x this year's expected earnings and some even lower.
Costco (COST), an excellent business, in contrast sells at an earnings multiple north of 20x (though if you take the rather conservative balance sheet into account, the $ 3 billion of net cash, it looks a bit less expensive).
On a forward earnings basis, Home Depot and Lowe's look a bit more reasonably priced.
While forward estimates vary, and are naturally less reliable, 12-13x earnings next year doesn't seem a stretch. What makes their valuations somewhat more compelling is the continued weakness in housing. If they remain as profitable as they are in this environment, I'm guessing they will be doing just fine several years down the road when the housing market begins to improve.
I happen to like Lowe's slightly more than Home Depot but both are fine businesses in my view.
(Lowe's has been in Stocks to Watch and the Six Stock Portfolio since their inception.)
(Lowe's has been in Stocks to Watch and the Six Stock Portfolio since their inception.)
Lowe's, which has struggled somewhat more than Home Depot, appears to be acting in a very shareholder-friendly manner. Home Depot also seems to be doing some very smart things including improved execution in recent years.
This article in MarketWatch highlights Lowe's plan to reduce shares outstanding via its buyback plan. Over five years Lowe's expects to repurchase $ 18 billion of its common stock. As a result, at least near current prices, its share count would be more than cut in half.
Lowe's is expected to earn $ 2.0 billion this year and $ 2.5 billion next year. If share count is reduced by half from the current 1.33 billion shares over the next five years, Lowe's earning per share would grow to $ 3.75/share even if net earnings does not grow beyond next years expected level.
At a 12.5x multiple of those $ 3.75/share in earnings (it currently sell for a ~14x multiple) in 2016, Lowe's would sell at ~$ 47/share. The stock currently sells at $ 23/share. That's more than a 14% annualized gain (total return would be even higher when you include 2.4% dividend).
The problem is I don't consider that buyback realistic.*
In the real world, odds are the stock will go up before they can accomplish the buyback near current prices. So it would be surprising if they end up being able to complete all $ 18 billion in five years at attractive prices. That means share count will likely drop less even if still by a material amount.
Let's look at an only somewhat more reasonable scenario. If they were able to buyback $ 15 billion of shares for an average price of $ 25/share (shares currently selling at ~ $23/share), the company's shares outstanding would still drop from 1.33 billion to .733 billion over five years. This buyback could also be accomplished with a more manageable amount of incremental debt and interest expense.
At that share count, Lowe's earnings per share would grow to $ 3.40/share using, again, next year's expected level of earnings (including interest expense from incremental debt). I will say that it's likely Lowe's will be earning much more than that five years from now.
At that reduced share count, assuming a 12.5x earnings multiple of those earnings, Lowe's would still sell at $ 42.50/share in 5 years. With the stock currently selling at $ 23/share, that's still slightly more than a 12.6% annualized gain (if you include the 2.4% dividends more like a 15% annualized total return).
In both cases, those returns come about using modest growth assumptions and a relatively low multiple of earnings.
It's worth asking the question: what if the multiple shrinks? Well, the answer is different for someone who's investing strictly over short time horizons versus an investor with some patience. For the patient long-term investor, if the multiple shrinks the company gets to buy back more the stock at lower prices ultimately resulting in even better returns. So, if the stock were to rally meaningfully above that $ 25/share average repurchase price, overall returns will end up being lower over the long haul. Shareholders who don't plan to sell for many years shouldn't be so pleased when the shares of a good business (with the capacity to buyback at a discount) rally in the near-term.
The near-term, and even intermediate-term, rally purely benefits the trader and hurts the long-term owner. On the other hand, if it gets closer to the time that the shares are going to be sold -- and after many years of well-executed buyback -- the stock were to end up selling at a high multiple of earnings, that'd be a very good thing.
The near-term, and even intermediate-term, rally purely benefits the trader and hurts the long-term owner. On the other hand, if it gets closer to the time that the shares are going to be sold -- and after many years of well-executed buyback -- the stock were to end up selling at a high multiple of earnings, that'd be a very good thing.
This obviously doesn't quite fit with some of the more hyperactive trading strategies. In that more speculative world, I'm guessing 1-2 months would be a considered a long time. Yet, I think, a little time with a simple spreadsheet reveals the folly of trying to figure out how something will perform in three years or less when the average annual return becomes so compelling if the investor increases their investing horizon by at least a few more years.**
This fact seems lost of those involved with investing over shorter time horizons. The only way this ends up not working out is if something materially negative happens to economic moat of the business or management starts misallocating capital.
That's why I happen to think, besides buying with an appropriate margin of safety, investing successfully is mostly about understanding and monitoring the sustainability of competitive advantage and management capital allocation skills.
What are the threats to the advantages that drive the core economics of a business?
Is the management doing smart things with capital?
As I mentioned, Lowe's and Home Depot have been able to earn a healthy amount in what is a terrible environment for housing. An environment that is likely to persist for quite a while yet certainly not forever.
Some time down the road a housing recovery of some sort will kick in and earnings will likely be substantially higher. If that does happen, the price to earnings multiple will also likely expand.
Consider that as upside.
Consider that as upside.
A very attractive scenario for long-term investors in Lowe's would be:
1) The stock stays low, for several years, allowing a large number of shares to be bought back using the least amount of capital possible, followed by 2) a normal housing boom (i.e. not a bubble) kicking into gear.
That will make the stock so-called "dead money" and some will no doubt try to time it. My premise is that if you try to time it you end up with the risk of owning "an eyedropper" (or none) of something when you wanted to own a substantial amount. I'm not saying Lowe's as an investment is all that unique. It's just a good example. There are no doubt better investment opportunities. In fact, quite a few very good low multiple businesses currently have very similar shareholder enriching buyback opportunities.
It's just that when investors decide they like a business, and the price it is available at is fair, it makes no sense to try and time it because of fear that it will be so-called "dead money". I realize this doesn't fit the ethos of the fast money world we live in.
Some final thoughts on Lowe's.
One real possibility is that Lowe's stock goes down further in the short-term. From a buyback (and, of course, long-term returns) perspective that would be a good thing. Stock traders may hate this but investors should welcome it.***
Lowe's near or intermediate term stock performance could easily continue to be unimpressive. Yet, as long as the business continues to have solid core economics, the longer that underperformance in the stock persists the better returns will likely be for shareholders with a long-term investment time horizon.
So with any investment, monitor those things that may adversely impact the long-term economics. Focus on the source of durable competitive advantage and what may be a threat to it.
Otherwise, the arithmetic of what returns will be ends up being five year plus down the road is pretty simple.
Adam
I have long positions in LOW and WMT
* It's clear they would have to take on some $ 6 to $ 8 billion in additional debt to accomplish this within 5 years at current expected earnings and free cash flow levels. I think their balance sheet gives them the room to do so but it does add risk. In this example, we are basically assuming that operating earnings could grow enough to pay the incremental after-tax interest expense. Not a foregone conclusion but, at the same time, seemingly not a stretch either. It's important -- assuming they remain financially and competitively strong -- that they only buyback shares when selling at a plain discount to per share intrinsic value. So meeting that $ 18 billion expectation should take a back seat if the stock gets rather expensive. Also, whether a buyback makes sense will naturally depend upon whether the cash could be bettered used building/strengthening the business (or maybe to make a smart acquisition). Maintaining and strengthening the moat is paramount. That should always take priority over a buyback and, well, pretty much everything else. In all cases, the decision should come down to what will produce the highest returns on capital, with all risks carefully considered, over the long haul. Pursuit of growth that's high risk/low return should be avoided. This seems like it should be obvious but, even with good intentions, growth initiatives too often end up producing lower returns at greater risk compared to simply buying back a cheap stock.
** Average annual return is all that matters even if much of the return ends up back-end loaded. Some will try to time it. Best of luck. That's a recipe to miss perfectly sound long-term investments. You don't get great prices unless something is going to be dead money or, in fact, declining for a quite a while. If you are an institutional investor, pressure will probably prevent you from being allowed to invest in this manner. Individuals with a long-term investing horizon only impose that pressure on themselves.
*** What's an exception to this? Here's a scenario to consider: unfortunately, there's the very real risk that, while the stock is down, a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.
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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.
*** What's an exception to this? Here's a scenario to consider: unfortunately, there's the very real risk that, while the stock is down, a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.
---
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, June 6, 2011
The World After QE2
Things were not pretty for the stock market after the end of QE1.
Some are bracing for the same kind of thing with the end of QE2 fast approaching.
I'm not in the business of guessing what the market will do. If the market goes down substantially I buy good businesses at a discount. If it goes to the other extreme, may sell some things that get expensive. That's the extent of my interest in predicting what the market will do.
Having said that, the following article argues that there are some reasons to think that the end of QE2 may not necessarily be a repeat of what happened after QE1.
From Michael Santoli's article in the latest Barron's Magazine:
What's in store post-QE2?
"Hopefully, not much," says Michael Darda...He and others see important differences in the macro backdrop...
At least compared to March of 2010. Some of those important differences...
Credit Spreads Remain Narrow
Darda takes crucial cues from the credit and interbank money markets, both of which are rather unperturbed...
Commercial-Loan Production, Money-Supply Now Growing
A year ago, the banking system was still suffering declines in commercial-loan production, whereas business lending now has turned higher.
The article points out that we now have far more positive money-supply growth. So it would seem the end of QE2 isn't likely to end up being the real problem. It, at least, appears that there is more of a cushion to absorb shocks than there was a year ago, but Santoli points out it makes sense to keep what Mike Tyson once said in mind:
"Everyone has a plan, until they get hit." But the blows, should they come, probably will be from some financial accident in Europe or elsewhere, a downshift in global growth or another shot to corporate confidence—not the end of QE2.
Santoli also points out that the stock market may be higher than a year ago but, in fact, corporate-profit growth has outpaced shares price increases. So stocks in general are not expensive.
I partially agree.
The article highlights companies with clear pricing power in a deflationary arguing that they should do well.
Specifically, it mentions stocks like Philip Morris International (PM), Union Pacific (UNP), Kansas City Southern (KSU), and Schlumberger (SLB). I certainly like Philip Morris International (it has been in the 6 Stock Portfolio and Stocks to Watch since inception) and to a lesser extent Union Pacific, but both of the stocks have gone from being bargains to, if not expensive, certainly not cheap.
Consider that Philip Morris International had a single digit price to earnings multiple when it was first mentioned on this blog as being a good investment at prices available back in April of 2009.
After the rally, from a share price that was back then in the high 30's to where it trades now in the high 60's, that multiple is now in the mid-teens.
It is still a great business, and if held for a very long time returns will be just fine, but these days there are shares in other companies selling at bigger discounts to intrinsic value in my view.
If it ever gets cheap again (and you don't mind owning a tobacco company) those shares are well worth owning as a long-term core holding.
Adam
Long PM and UNP
Some are bracing for the same kind of thing with the end of QE2 fast approaching.
I'm not in the business of guessing what the market will do. If the market goes down substantially I buy good businesses at a discount. If it goes to the other extreme, may sell some things that get expensive. That's the extent of my interest in predicting what the market will do.
Having said that, the following article argues that there are some reasons to think that the end of QE2 may not necessarily be a repeat of what happened after QE1.
From Michael Santoli's article in the latest Barron's Magazine:
What's in store post-QE2?
"Hopefully, not much," says Michael Darda...He and others see important differences in the macro backdrop...
At least compared to March of 2010. Some of those important differences...
Credit Spreads Remain Narrow
Darda takes crucial cues from the credit and interbank money markets, both of which are rather unperturbed...
Commercial-Loan Production, Money-Supply Now Growing
A year ago, the banking system was still suffering declines in commercial-loan production, whereas business lending now has turned higher.
The article points out that we now have far more positive money-supply growth. So it would seem the end of QE2 isn't likely to end up being the real problem. It, at least, appears that there is more of a cushion to absorb shocks than there was a year ago, but Santoli points out it makes sense to keep what Mike Tyson once said in mind:
"Everyone has a plan, until they get hit." But the blows, should they come, probably will be from some financial accident in Europe or elsewhere, a downshift in global growth or another shot to corporate confidence—not the end of QE2.
Santoli also points out that the stock market may be higher than a year ago but, in fact, corporate-profit growth has outpaced shares price increases. So stocks in general are not expensive.
I partially agree.
The article highlights companies with clear pricing power in a deflationary arguing that they should do well.
Specifically, it mentions stocks like Philip Morris International (PM), Union Pacific (UNP), Kansas City Southern (KSU), and Schlumberger (SLB). I certainly like Philip Morris International (it has been in the 6 Stock Portfolio and Stocks to Watch since inception) and to a lesser extent Union Pacific, but both of the stocks have gone from being bargains to, if not expensive, certainly not cheap.
Consider that Philip Morris International had a single digit price to earnings multiple when it was first mentioned on this blog as being a good investment at prices available back in April of 2009.
After the rally, from a share price that was back then in the high 30's to where it trades now in the high 60's, that multiple is now in the mid-teens.
It is still a great business, and if held for a very long time returns will be just fine, but these days there are shares in other companies selling at bigger discounts to intrinsic value in my view.
If it ever gets cheap again (and you don't mind owning a tobacco company) those shares are well worth owning as a long-term core holding.
Adam
Long PM and UNP
Friday, June 3, 2011
Buffett on Mergers: Berkshire Shareholder Letter Highlights
From Warren Buffett's 1992 Berkshire Hathaway (BRKa) shareholder letter:
We had a significant investment in a bank whose management was hell-bent on expansion. (Aren't they all?) When our bank wooed a smaller bank, its owner demanded a stock swap on a basis that valued the acquiree's net worth and earning power at over twice that of the acquirer's. Our management - visibly in heat - quickly capitulated. The owner of the acquiree then insisted on one other condition: "You must promise me," he said in effect, "that once our merger is done and I have become a major shareholder, you'll never again make a deal this dumb."
Sometimes (in fact, too often) an acquisition does more to expand management's domain than increase shareholder value.
Management, in order to gain approval, will sometimes make the case for a more-than-fully-priced acquisition using words like strategic or synergistic. Even if the deal works out okay operationally (not exactly a foregone conclusion by the way) the odds are good that existing shareholders will end up poorer when an obviously expensive price is being justified on the basis of the deal being strategic or synergistic.
There are exceptions, of course, but strategic and synergistic is often just code for "this makes my empire bigger at shareholder expense". The fact that shareholders end up a bit poorer, a mere inconvenience.
Keep in mind that, throughout the acquisition process, you can expect management to remain adamant that the deal truly is about enhancing shareholder returns. Yet, when it's all said and done, if you overpay, the transaction is just a complicated way to transfer some of your wealth to the acquiree's shareholders.
Here is a related previous post. In it, Buffett describes some of the ways that management rationalizes issuing stock to purchase another company.
Previous post: Buffett on Favorite Rationalizations
A good business, run by management that sincerely does deals/makes capital allocation decisions with shareholder wealth creation in mind, can be owned for a very long time.
Adam
Long BRKb
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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 are never a recommendation to buy or sell anything.
We had a significant investment in a bank whose management was hell-bent on expansion. (Aren't they all?) When our bank wooed a smaller bank, its owner demanded a stock swap on a basis that valued the acquiree's net worth and earning power at over twice that of the acquirer's. Our management - visibly in heat - quickly capitulated. The owner of the acquiree then insisted on one other condition: "You must promise me," he said in effect, "that once our merger is done and I have become a major shareholder, you'll never again make a deal this dumb."
Sometimes (in fact, too often) an acquisition does more to expand management's domain than increase shareholder value.
Management, in order to gain approval, will sometimes make the case for a more-than-fully-priced acquisition using words like strategic or synergistic. Even if the deal works out okay operationally (not exactly a foregone conclusion by the way) the odds are good that existing shareholders will end up poorer when an obviously expensive price is being justified on the basis of the deal being strategic or synergistic.
There are exceptions, of course, but strategic and synergistic is often just code for "this makes my empire bigger at shareholder expense". The fact that shareholders end up a bit poorer, a mere inconvenience.
Keep in mind that, throughout the acquisition process, you can expect management to remain adamant that the deal truly is about enhancing shareholder returns. Yet, when it's all said and done, if you overpay, the transaction is just a complicated way to transfer some of your wealth to the acquiree's shareholders.
Here is a related previous post. In it, Buffett describes some of the ways that management rationalizes issuing stock to purchase another company.
Previous post: Buffett on Favorite Rationalizations
A good business, run by management that sincerely does deals/makes capital allocation decisions with shareholder wealth creation in mind, can be owned for a very long time.
Adam
Long BRKb
---
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 are never a recommendation to buy or sell anything.
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