Selling Wal-Mart Back to the Walton Family: Part 1

Berkshire Hathaway (BRKA) has a large position in Wal-Mart (WMT). This Barron's article makes the following point about the stock:

...Wall Street is selling the company back to the Walton family. As Wal-Mart has bought back shares at a brisk $15 billion annual clip, the Waltons' ownership is back above 48% and growing every day. Grant's Interest Rate Observer, always keen for contrarian value plays, notes somewhat facetiously that at the current buyback rate, in 15 years there will be one share outstanding.

Taking full advantage of an increasingly inexpensive stock (i.e. earnings grew while stock went nowhere) in recent years, Wal-Mart's (WMT) share count has been reduced by more than 20% via buybacks over the past decade.

Wal-Mart is, in many ways, a long duration bond with a growing coupon in the form of its persistent earnings stream. The buybacks make a ton of sense for a company selling well below its intrinsic value.

It seems to get little attention but, in contrast, Amazon (AMZN) has actually had its shares outstanding grow by more than 25% over the past decade.

A more than meaningful increase.

When a stock is cheap, buying back the shares makes a lot of sense if a company is: financially strong, has a secure economic moat (ideally one that is being expanded/strengthened over time), and no other strategic need for corporate cash.
(Cheap being when shares sell below a conservative estimate of intrinsic business value.)

When shares are expensive, the buybacks should at least be halted. I say at least because, in some circumstances, if the stock sells far enough above intrinsic value it makes sense to sell some shares. Most executives however, for obvious reasons, dislike signaling that the stock is expensive so that doesn't often happen.

What's the next best thing? Avoid buying back the stock and allow the exercise of options to balloon the share count.

Many additional Amazon shares outstanding have been added through the exercise of employee stock options. The ongoing exercise of stock options, if not offset by buybacks, increases shares outstanding.* The cumulative effect, sometimes rather quietly over time, can end up being significant. There's been some buybacks over the years at Amazon but not nearly enough to provide an offset to the share count growth (besides the shares have frequently been far from cheap).

The growth in share count is a bit of a slow burn with the larger impact on shareholders only made evident over many years**.

It's worth noting that some were arguing with a straight face that options are not real expenses not too long ago. Here's the take of Warren Buffett and Charlie Munger on the debate over expensing options. Buffett starts by telling the crowd that the state of Indiana actually tried to change the value of pi in the 19th-century. Well, the bill did pass the Indiana house but, fortunately, the Indiana senate stopped it.

From the 2004 Berkshire Hathaway Annual Meeting:

CNN Money Article

"It seems there was a fellow who discovered some new relationship between circumference and diameter that would help students learn a better kind of geometry, so he wrote a law to change the value of pi from 3.14159 etc. to 3.20. It passed the Indiana house -- until the Indiana senate finally thought better of it."

After the audience stopped laughing, Buffett came to his point about options, "The U.S. Senate concluded that the world was flat, because their contributors paid them enough to say the world was flat."

Then Munger weighed in: "It's worse than that. Those people who wanted to round pi to 3.2 were stupid. These people [the opponents of expensing options] are worse than stupid. They know it's wrong and want to do it anyway."

Back to Wal-Mart. These days, Wal-Mart sells at roughly 12x current-year earnings. The Barron's article also points out Wal-Mart has plenty of growth outside the U.S. but seems to get little credit for it.

Consider that Wal-Mart had $ 16.39 billion in earnings compared to Amazon's rather smallish $ 1.15 billion last year.

So Wal-Mart earns every 3.5 weeks or so what Amazon earns in a year.

Yet, Amazon has anything but a smallish market value. Its market value is now close to $ 100 billion compared to Wal-Mart's $ 185 billion.

I'll follow up on this in another post.

Adam

Long position in Wal-Mart

Selling Wal-Mart Back to the Walton Family - Part II

* When options are exercised, it affects the corporate cash holdings and shares outstanding. The holder of the option pays the strike price to the company upon the exercise of stock options. As a result, the corporate cash increases and new shares are issued. So some of the dollars from the transaction (the strike price x shares exercised) ends up in corporate coffers. In the end, an exercise of employee stock options results in an increase to cash on the balance sheet, an increase to shares outstanding, and the employee gets compensated by the amount above the strike price. Check out Box 2, on page 6 of this paper for a good explanation. In addition, employee stock options provide meaningful tax benefits to the company. This article also provides a simple explanation of how the exercise of employee stock options impacts corporate cash holdings an the tax benefits among other things. 
** Shares outstanding has gone from 4.48 billion to 3.51 billion for Wal-Mart and from 364 million to 459 million for Amazon over ten years.
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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.

The 'New Normal' & 'Black Swans'

"We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops..." - Bill Gross of PIMCO in his September 2009 Investment Outlook

"Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse." - Nassim Taleb in his book: The Black Swan

Warren Buffett, the CEO of Berkshire Hathaway (BRKa), and Muhtar Kent, the CEO of Coca-Cola (KO), were recently on CNBC. Below are some excerpts of their responses to questions about the so-called 'New Normal' and 'Blacks Swans'.

On the 'New Normal'
Buffett: "...there's always a new normal...I think the luckiest person around is the baby that's born in the United States today. I don't think there's any question about it. I mean, I— it— that person is going, on average, to enjoy a far better life, you know, than John D. Rockefeller had many years ago or that I have now."

He later added...

"...so I think if there's a new normal, it will be a higher normal in terms of the average person of how they lived 20 years from now and 50 years from now."

Coca-Cola's CEO Muhtar Kent added the following...

Kent: "We have a young population. By 2040, in terms of the number of people over 60, the United States is going to be a lower percentage than China or certainly Japan and Western Europe. We have a young population.

We've got a very enterprising demographic and population, diverse, multicultural, more than 50 percent of the educated immigrants around the world are coming to the United States. Innovative, you know, we've got— we register more than 50 percent of the patents around the world. The women entrepreneurs in the United States account for $4 trillion. That's the same economy— size as the Chinese economy."

On 'Black Swans'
Buffett: "...we will have black swans, but we'll overcome black swans. Carl, I was born in August of 1930. You know, if a genie had come to me and said, 'Warren, in the next— in the next two years, the Dow is going to go from 180 down to 40, there's going to be 4,000 banks close. You know, there's going to be a dust bowl in Nebraska where you live, and farm prices are going to go to hell, and in another 10 years we're going to have a surprise attack by an enemy that looks like it's going to win the war for a while, we're going to have nuclear bombs', you know, I'm not sure I would have come out? But the truth was that America, in the 80 years since I've been born, the average person lives six times better than when I was born. It's unbelievable what this country delivers. And we haven't— we haven't lost the magic potion at all. If anything, we've got more opportunity now than we've ever had."

It seems, post-financial crisis, we have many very compelling explanations of why the future beyond 2011 is somehow destined to be subpar.

In the context of what has recently happened, it makes some sense that those with dire predictions would have the upper hand in terms of prevailing opinion and media coverage.

So what does this mean for investors? It's worth keeping what Warren Buffett said back in 2001 in mind:

"People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them." - Warren Buffett in Fortune, December 2001

"The public's monumental hangover from its stock binge of the 1920s lasted...through 1948. The country was then intrinsically far more valuable than it had been 20 years before; dividend yields were more than double the yield on bonds; and yet stock prices were at less than half their 1929 peak...But rather than seeing what was in plain sight in the late 1940s, investors were transfixed by the frightening market of the early 1930s and were avoiding re-exposure to pain.

Don't think for a moment that small investors are the only ones guilty of too much attention to the rear-view mirror. Let's look at the behavior of professionally managed pension funds in recent decades. In 1971--this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!" - Warren Buffett in Fortune, December 2001

More recently, in the late 1990s when extreme optimism was pervasive and stocks were expensive, many were buying stocks aggressively.

In early 2009, it was pretty much the opposite. These days, we're somewhere in between those two extremes.

Neither extreme view had a great probability of being correct in the long run. The imbalances and systemic risks generally get sorted out even if not a pleasant experience while it's happening. It's not like the Great Depression leading straight into World War II was a cakewalk. Some of the best opportunities to invest are when the headlines are the worst (I'm guessing buying a stock circa 1938 didn't feel so great).

There may be new forms of messiness and kinds of risk in the world but it's not like the journey has historically ever been smooth sailing for investors or otherwise. Over the long haul, despite the many often severe financial/military/political disruptions, living standards increased substantially while the value created by good businesses continued to multiply many times.

None of this, of course, applies to traders. The time horizon has got to be measured in more than days or weeks (or even just a few years for that matter).

From this New York Times article:

The 'New Normal' is Actually Pretty Old

Everyone needs to get over the fear of the "new normal."

Chief among these advocates was David Laibson, an economics professor at Harvard who was recently co-author of a paper on exactly this subject. In the paper, and in person, Professor Laibson argued that the economy will always revert back to its long-term growth trend, but people still tend to freak out about sudden shocks to the system in the short-term and assume they present a permanent diversion from that long-run trend. 

If an extremely bearish or bullish view of the future happens to be trumpeted louder, more frequently, and more articulately in the media at any point in time that doesn't make those views more correct.

I've Had Just About Enough 'New Normal' to Last Me a Lifetime

The known global economic problems we face are not small. There are no doubt other serious challenges not even on our radar as of yet. Some of these known or as yet unknown troubles will create very significant disruptions in the future.

Some of this will even mean stocks end up much lower from time to time. Another crisis is always out there, some foreseeable, others not so much. Consider it a normal part of the investing environment and focus on buying a good businesses at the right price.

"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Davis

Successfully timing these things is impossible to do consistently. The good news is timing doesn't matter much when quality businesses are bought when selling at a discount to conservatively calculated value.

Businesses don't sell at discounts during the good times. The best chances to invest with a margin of safety will always be well before the clouds have cleared from the skies.

Adam

Long BRKb and KO

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.

Buffett: "Look-Through" Earnings Revisited - Berkshire Shareholder Letter Highlights (BRKa, AXP, KO, MTB, WPO, WFC)

One of the concepts that Warren Buffett has emphasized in a number of the annual shareholder letters over the years is the importance of "look-through" earnings.

From the 1999 Berkshire Hathaway (BRKa) shareholder letter:

Reported earnings are an inadequate measure of economic progress at Berkshire, in part because the numbers shown in the table presented earlier include only the dividends we receive from investees -- though these dividends typically represent only a small fraction of the earnings attributable to our ownership. Not that we mind this division of money, since on balance we regard the undistributed earnings of investees as more valuable to us than the portion paid out. The reason for our thinking is simple: Our investees often have the opportunity to reinvest earnings at high rates of return. So why should we want them paid out?

To depict something closer to economic reality at Berkshire than reported earnings, though, we employ the concept of "look-through" earnings. As we calculate these, they consist of: (1) the operating earnings reported in the previous section, plus; (2) our share of the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less; (3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us. When tabulating "operating earnings" here, we exclude purchase-accounting adjustments as well as capital gains and other major non-recurring items.

The following table sets forth our 1999 look-through earnings, though I warn you that the figures can be no more than approximate, since they are based on a number of judgment calls.
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	Berkshire's Approximate	Berkshire's Share of Undistributed
Berkshire's Major Investees	Ownership at Yearend(1)	Operating Earnings (in millions)(2)
American Express (AXP)	11.3%	$228
Coca-Cola (KO)	8.1%	144
Freddie Mac ....	8.6%	127
The Gillette Company ....	9.0%	53
M&T Bank (MTB)	6.5%	17
Washington Post (WPO)	18.3%	30
Wells Fargo (WFC)	3.6%	108
Berkshire's share of undistributed earnings of major investees		707
Hypothetical tax on these undistributed investee earnings(3)		(99)
Reported operating earnings of Berkshire		1,318
Total look-through earnings of Berkshire		$ 1,926
		=====

     (1) Does not include shares allocable to minority interests
     (2) Calculated on average ownership for the year
     (3) The tax rate used is 14%, which is the rate Berkshire pays on the dividends it receives 

Naturally, most portfolios do not have operating earnings so the undistributed earnings minus hypothetical taxes is the "look-through" earnings. The calculation is a worthwhile exercise. I gauge the progress of a portfolio primarily based upon the growth in those "look-through" earnings over time not the change in stock prices.

This helps erase the noise that is created by market prices. If the "look-through" earnings grow at a satisfactory rate, while the competitive advantages of the businesses remain in tact (or ideally become larger over time), then returns will work out just fine in the long run.

Well, at least if shares were bought at fair prices in the first place.

Adam

Long positions in BRKb, AXP, KO, and WFC

Related post: Buffett on "Look-Through" Earnings

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.

Van Den Berg: "Large cap stocks...presently at historic lows relative to small cap stocks"

In this GuruFocus interview, Arnold Van Den Berg of Century Management named the investors he admires most:

- Benjamin Graham
- Warren Buffett
- Walter Schloss
- Prem Watsa
- T. Rowe Price (the person)
- John Templeton
- Philip Fisher
- Peter Lynch
- John Neff
- Seth Klarman

He also made the point that they are all investors whose writings are worth checking out.

Van Den Berg also says that large cap tech stocks (and large caps in general) are inexpensive. The top 5 five holdings and additions revealed in Van Den Berg's just released second quarter portfolio certainly supports that view.

This GuruFocus article summarizes the portfolio and the key changes in more detail. 

The top five holdings make up more than 20% of the portfolio.

In last month's interview, he also made the following comments:

"At today's prices, a significant number of the large cap stocks we own are priced as though they will experience negative sales & earnings growth. We feel these assumptions are too onerous as the companies benefit from emerging market demand growth..."

Later in the interview he added:

"I believe large cap tech stocks are one of the cheapest areas of the market."

For those with some patience, market prices of some of the better business franchises still provide more than a decent margin of safety in my view (even if not a true fat pitch).

Certainly, the discounts to value of some quality large cap business franchises not long ago became wider than I ever thought I'd see. Some remain fairly cheap, if not as much so, even if the market as a whole is not.

Now, why have these businesses become so cheap? It wouldn't be tough to come up with a few logical reasons why. Each business, of course, has a unique set of challenges.

I'm guessing that efficient market true believers and even half-believers won't like the following explanation: The reason some perfectly good businesses sell at a discount to value these days is no more logical than the reason some of these same businesses were extremely expensive a decade ago.

Check out the full interview with Van Den Berg.

Adam

Related posts:
Van Den Berg: Large Cap Technology Stocks Are Cheap
Technology Stocks

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.

Buffett on Bold & Imaginative Accounting: Berkshire Shareholder Letter Highlights

Warren Buffett wrote the following in the 1998 Berkshire Hathaway (BRKa) shareholder letter:

"A distressing number of both CEOs and auditors have in recent years bitterly fought FASB's attempts to replace option fiction with truth and virtually none have spoken out in support of FASB. Its opponents even enlisted Congress in the fight, pushing the case that inflated figures were in the national interest.

Still, I believe that the behavior of managements has been even worse when it comes to restructurings and merger accounting. Here, many managements purposefully work at manipulating numbers and deceiving investors. And, as Michael Kinsley has said about Washington: 'The scandal isn't in what's done that's illegal but rather in what's legal.'

It was once relatively easy to tell the good guys in accounting from the bad: The late 1960's, for example, brought on an orgy of what one charlatan dubbed 'bold, imaginative accounting' (the practice of which, incidentally, made him loved for a time by Wall Street because he never missed expectations). But most investors of that period knew who was playing games. And, to their credit, virtually all of America's most-admired companies then shunned deception.

In recent years, probity has eroded. Many major corporations still play things straight, but a significant and growing number of otherwise high-grade managers -- CEOs you would be happy to have as spouses for your children or as trustees under your will -- have come to the view that it's okay to manipulate earnings to satisfy what they believe are Wall Street's desires. Indeed, many CEOs think this kind of manipulation is not only okay, but actually their duty.

These managers start with the assumption, all too common, that their job at all times is to encourage the highest stock price possible (a premise with which we adamantly disagree). To pump the price, they strive, admirably, for operational excellence. But when operations don't produce the result hoped for, these CEOs resort to unadmirable accounting stratagems. These either manufacture the desired 'earnings' or set the stage for them in the future.

Rationalizing this behavior, these managers often say that their shareholders will be hurt if their currency for doing deals -- that is, their stock -- is not fully-priced, and they also argue that in using accounting shenanigans to get the figures they want, they are only doing what everybody else does. Once such an everybody's-doing-it attitude takes hold, ethical misgivings vanish. Call this behavior Son of Gresham: Bad accounting drives out good."

In a post back in May, I said that the best defense for investors is to buy businesses run by managers with a strong reputation and track record of fostering a conservative accounting culture. This is, unfortunately, not as easy to identify or find as it ought to be.

Buffett on Earnings Precision

"The term 'earnings' has a precise ring to it. And when an earnings figure is accompanied by an unqualified auditor's certificate, a naive reader might think it comparable in certitude to pi, calculated to dozens of decimal places.

In reality, however, earnings can be as pliable as putty when a charlatan heads the company reporting them." - Warren Buffett in the 1990 Berkshire Hathaway Shareholder Letter

All things being equal -- and they never are, of course -- I'd buy a slightly inferior business if I thought the management could be trusted to not inflate the score.

Accounting standards provides useful tools. Yet, understanding the inherent limitations of the tools is crucial for investors. The numbers that go into a company's 10-K or 10-Q are not nearly as absolute as we'd all like them to be.

"Obviously, you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization. I've heard it came to civilization through Venice which of course was o­nce the great commercial power in the Mediterranean. However, double-entry bookkeeping was a hell of an invention.

But you have to know enough about it to understand its limitations - because although accounting is the starting place, it's o­nly a crude approximation." - Charlie Munger in a talk he gave in 1994 at USC Business School

The problem is that earnings are not particularly precise even when management is doing its best to report the numbers honestly. Yet, when you're confident that the numbers management and the auditor's agree to put up on the scoreboard are a conservative representation of performance, the limitations of accounting should matter a whole lot less.

Conservative scorekeeping makes it easier to be certain you are, in fact, obtaining share ownership with the appropriate margin of safety. You'll be less likely to pay an inflated price resulting from either being misled deliberately by management, or the inherent limits of accounting itself.

So own businesses run by honest and capable management who tend to report the numbers conservatively. This, itself, won't make you rich but it will reduce the probability of waking up some morning only to find out that something you own is actually worth 50 cents on the dollar or worse.

Accounting rules will no doubt change over time but won't end attempts by some to be less than conservative with how the numbers are presented.

Adam

Long position in BRKb

Charlie Munger at USC Business School in 1994

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.

Charlie Munger on Accountants & High-Speed Traders

More From Charlie Munger at what was effectively the final Wesco Financial annual meeting.

Charlie has had a loyal following to this event for years but Wesco is no longer publicly traded after Berkshire Hathaway (BRK-A) acquired the remaining shares of the company last month.

With Wesco no longer a public company the gathering was given the title: "A Morning With Charlie".

The conference was promised to investors as a replacement for the annual shareholder meeting and paid for by Charlie himself.

From this The Motley Fool article:

Charlie Munger's Thoughts on the World: Part 1

On Accountants
"The medical profession wants to eradicate epidemics. Accountants feel no similar responsibility toward their field. They feel no embarrassment about it. They just want to get the job done. It's contemptible behavior. At the top of an idiot boom, a bank's allowance for bad debt goes to zero. That's the accounting rule. What kind of maniac thinks this is good? A certified public accountant, that's who."

On High-Speed Traders
"Fancy computers are engaging in legalized front-running. The profits are clearly coming from the rest of us -- our college endowments and our pensions. Why is this legal? What the hell is the government thinking? It's like letting rats into a restaurant."

Well said, Mr. Munger.

So the maniac accountants are not, well, accountable enough and the idea of allowing high speed traders in the market is equivalent to letting rats in a restaurant.

Just the kind of blunt commentary most who've followed Charlie Munger have come to expect.

Adam

Long BRKb

Related posts: 
Final Wesco Meeting: More From Charlie Munger

Final Wesco Meeting: A Morning With Charlie Munger

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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.

A Derivative of a Derivative

Below is an excerpt from a recent article in Barron's by Michael Santoli. Here's his take on products that facilitate the making of directional bets on the VIX (VIX) index via ETFs that own VIX Futures.

An example, among many others, of so-called product innovations that have created convenient ways to bet on subtle market relationships.

I wouldn't go near these vehicles. In most cases, they are worse than useless.

Here's a couple of excerpts:

There are more than a dozen ETFs that allow everyone, including your boneheaded neighbor, to trade permutations of the VIX index...

Santoli goes on to explain that...

Millions of dollars a day...are traded in a derivative of a derivative of a statistical byproduct of other derivatives' pricing.

No wonder investors generally are glum and perplexed. Not only is there little low-hanging fruit, but investors feel forced to climb to the top of trees just to eat the leaves.

Check out the full article. It might actually be comical if it wasn't such a serious mess.

Not only do we have more rapid fire trading than ever of plain vanilla equities, modern financial markets have increasingly become layers upon layers of side bets.

These bets have little or nothing to do with making markets function more effectively.

We don't need these kinds of innovation in finance. It's OK to be boring in finance. What we want is innovation in widgets. - Charlie Munger

Instead, they are best at generating fees/commissions that add nothing but costs and unnecessary complexity.

Better to buy shares in a good business when cheap and just avoid this kind of folly.

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.

Final Wesco Meeting: A Morning With Charlie Munger

Below is how Charlie Munger opened what was effectively the final Wesco Financial annual meeting along with some notes summarizing a few other comments he made of interest.

Charlie has had a loyal following to this event for years but Wesco is no longer publicly traded after Berkshire Hathaway (BRK-A) acquired the remaining shares of the company last month.

Since now no longer a separate public company the question was who'd pay for this event. Charlie decided to pay for it himself.

From this The Motley Fool article:

"Most of you know exactly what I think about every subject, but you still come anyway. It's a damn cult."

Charlie Munger's Thoughts on the World: Part 1

"You need a new cult hero," Munger said. "I'm doing you all a favor by not having another one of these meetings."

"We'll be talking about a lot today," he told the crowd of 500. "Some of it is academic. Some philosophical. And some will be about investments because I know you're all a bunch of greedy bastards."

On the Wall Street Meltdown
"The cause was a combination of megalomania, stupidity, insanity, and I would say evil on the part of bankers and mortgage brokers."

On Berkshire
"Berkshire's stock is at a point Buffett and I never anticipated it would go to.

Investors owning Berkshire at current prices will do quite all right just sitting on their rear ends."

On Derivatives
"We don't need these kinds of innovation in finance. It's OK to be boring in finance. What we want is innovation in widgets."

On See's Candies
"...we didn't know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no one cared. Learning that changed Berkshire. It was really important."

On Tech Stocks
"...it's hard to imagine Google (Nasdaq: GOOG) not having a strong position in the future. I don't know how you can replace Google. For other tech companies, of course there are very real threats."

It's notable that Munger apparently thinks Berkshire's stock currently presents a good value. He's not exactly been known to pump Berkshire's stock in the past. Actually, both Buffett and Munger have historically done quite the opposite. Their preference instead being that the stock fluctuate in a range that roughly approximates Berkshire's intrinsic value.

"...we would rather see Berkshire's stock price at a fair level than a high level. Obviously, Charlie and I can't control Berkshire’s price. But by our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it's-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners." - From the Berkshire Hathaway Owner's Manual:

"...managers start with the assumption, all too common, that their job at all times is to encourage the highest stock price possible (a premise with which we adamantly disagree)." - From the 1998 Berkshire Hathaway Shareholder Letter

Munger mentioned during the meeting that his favorite company outside Berkshire is, not surprisingly, Costco (NYSE: COST). His admiration for that company has been expressed on many occasions.

Like many, I have always looked forward to Charlie's blunt and insightful comments that come out of this meeting each year.

I, for one, in the absence of this meeting will hope that he continues to share his thoughts through interviews, speeches, and otherwise.

Check out the full article.

Adam

Long BRKb and GOOG

Related posts:
Final Wesco Meeting: More from Charlie Munger
Charlie Munger on Accountants & High-Speed Traders
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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.

Richard Bove: B of A "Massively Undervalued"

Here's a CNBC article on what Richard Bove thinks about Bank of America (BAC).

Bove estimates that Bank of America will have pretax pre-provision earnings of $131 billion in aggregate from 2011 through 2013.

In this recent post, I said I thought the question was whether any bank was worth the trouble considering the number of other reasonably valued assets available. Many things can go wrong for even the best bank, some beyond its control, that simply cannot for other businesses.

Based upon Bove's estimate of pretax pre-provision earnings, Bank of America's after tax net income should easily normalize above $ 20 billion/year.

Current market value is $ 111 billion giving it a multiple to normalized earnings of 5.6x.

There are better banks with fewer problems and complexities out there but they sell for higher multiples of normalized earnings. I happen to like* Wells Fargo (WFC) much more over the long haul but it looks expensive by comparison at 7.5 to 8x normalized earnings.

(Wells Fargo and Bank of America obviously sell at higher current year earnings multiples as they're still absorbing credit losses and writedowns)

Best not to bottom feed when it comes to owning a bank. Banks are always on the riskier end of the investing spectrum but Bank of America is certainly more so than something like Wells in my view.

Ultimately, assuming systemic risks don't get out of hand, it comes down to whether Bank of America can avoid more capital raising (especially when the stock is cheap). 

Eventually credit losses will become more normal and loan growth will kick into gear. If Bank of America is able to absorb future writedowns, systemic risks remain reasonably in check, and it's not hurt materially by hard to predict new regulatory requirements (lots of ifs) it will, at today's prices, probably look like a bargain.

Yet with banks, unlike some other more straightforward investments, lots can always go very wrong.

Adam

Long position in BAC and WFC

* Wells Fargo has been in Stocks to Watch and the Six Stock Portfolio since the inception of both. Bank of America, an inferior bank by a large margin in my view, is not.
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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.

Buffett on Speculation and Investment

From this CNBC interview with Warren Buffett:

"So there's two types of assets to buy. One is where the asset itself delivers a return to you, such as, you know, rental properties, stocks, a farm. And then there's assets that you buy where you hope somebody else pays you more later on, but the asset itself doesn't produce anything. And those are two different games. I regard the second game as speculation." - Warren Buffett

In yesterdays post, I basically said a well-designed system to support capital development, among other things, efficiently helps money meet a good idea with minimal frictional costs.

It will also more often than not produce market prices that, at least to a reasonable extent, approximate the discounted value of the cash a business can produce over its remaining life.

In reality, financial markets will always have a tendency to be alternatively manic then depressive in nature. The mood swings in markets are not going to stop producing prices in marketable securities that vary quite a bit, on both the high and low side, around the approximate underlying value of the assets.

Yet, I think modern financial markets have developed in a way that unnecessarily amplifies this nature. It's not like we're going to create a perfect system anytime soon but we'd be better off reversing the direction we've been heading for some time.

Some of this gets back to the question of what is speculation versus what is investing. The answer is clearly not black and white but that doesn't mean the differences are unimportant or small.

Investing is the ownership of an asset, partially or entirely, with the emphasis on benefiting from what that asset can produce in value itself over an extended period of time.

Speculating is altogether different. Speculation is betting on the near or even medium term price action of marketable securities. What the asset itself can produce in value over time is of little or, in the case of increasingly popular things like high frequency trading and technical analysis, of no interest. More from the CNBC interview:

"I bought a farm 30 years ago, not far from here. I've never had a quote on it since. What I do is I look at what it produces every year, and it produces a very satisfactory amount relative to what I paid for it." - Warren Buffett

If an investor buys something hoping the price will go up in the near-term, it's speculation. Investing is not about price action, it's about what the asset can produce in the long run relative to what was paid for the asset. What the price does next week, month, or even much longer matters little.

In a separate interview, Buffett had this to say:

"Basically, it's subjective, but in investment attitude you look at the asset itself to produce the return. So if I buy a farm and I expect it to produce $80 an acre for me in terms of its revenue from corn, soybeans etc. and it cost me $600. I'm looking at the return from the farm itself. I'm not looking at the price of the farm every day or every week or every year. On the other hand if I buy a stock and I hope it goes up next week, to me that's pure speculation." - Warren Buffett

So speculating is like investing the same way a Chihuahua is like a Doberman, a horse is like a zebra, and a house cat is like a lion. These things may seem, in some ways, very much the same but that's only if your definition of being the same is rather imprecise.

The differences matter.

There is certainly nothing wrong with speculation but the proportion of market participants that are speculators isn't exactly irrelevant. If most participants are focused more on price action, less on underlying value, it seems clear that the system will work below its potential. More frequent mispricings, sometimes substantial, seem an inevitable outcome.

To me, a market dominated by those focused on price action, less by those anchored by intrinsic value (the financial markets equivalent to gravity), naturally ends up with assets mispriced (on the high and low side) more frequently and by larger amounts. The more time and distance that prices remain disconnected from underlying value means ultimately more capital gets misallocated. This misallocation has got to be costly for all over the long haul*.

In the long run, the weighing machine wins (the financial equivalent to gravity assures this so a true long-term investor in a good business will do just fine) but in the short-to-intermediate run the system is less effective at performing its primary functions.

If I bought some farmland, owned it passively and rented it out to someone over the past 40 years, I think it's fair to say that I'm not a speculator in farmland. I primary look at the rent checks I collect over time to judge how wise the investment was. 

I become a passive part owner in a restaurant with the intention to own it "forever". While I may sell someday, what it could be sold for on any given day to someone else is not my focus.  I mainly judge my investment based on my share of the income and value it produces over many years relative to the price paid for the partial ownership. It's what the business produces relative to my capital at risk. I think in that scenario it's also fair to say I'm not a speculator in restaurants. 

The same is true for a long-term investor in something like Coca-Cola (KO) or Johnson & Johnson (JNJ). An investor who bought shares of either of stock in the early-to-mid 1980s now owns an asset that earns each year roughly what was paid for the stock (they are both remarkably consistent long-term value creators). Those earnings, of course, continue to grow. The dividend checks alone now easily produce a 40% return per year on the original capital invested (dividends that naturally also continue to grow). The dividend income stream alone represents a nice return even if those shares of Coca-Cola or Johnson & Johnson end up never being sold. Besides, selling means giving up the ownership of a proven productive asset and creates a new problem.

Finding another one.

If the market did not produce another quote on either Coca-Cola or Johnson & Johnson for a decade, the owner of shares would do just fine. The portion of the earnings that are not paid out as dividends, if management does its job, is invested in a manner that should create even more wealth for owners down the road.

I'm guessing, even if not quite as spectacular, someone who invests in these businesses now will not regret it in 25 years.

I'm not saying 25 or 30 years is somehow required to be considered an investment but a longer time frame helps make the point. There is room for speculators in any market. Yet, with the average holding period of stocks now standing at less than 3 months**, I think the proportion of participants in the market who think and behave like owners has clearly got to be too low (with prices more likely to swing wildly above and below the approximate intrinsic value of underlying assets).

When returns are primarily driven by well-timed trades around price action, it's speculating.

When returns are primarily driven by what the underlying asset produces in value over a long period of time, it's investing.

In reality, there's often a bit of each in any transaction but an emphasis more on the latter in the markets these days would be welcome.

Adam

Long stocks mentioned

Related posts:
Buffett on Gambling and Speculation (follow-up)
Buffett on Speculation and Investment - Part II (follow-up)

* Costly in terms of some opportunities getting undercapitalized while others end up swimming in capital who have questionable prospects or maybe don't even need the funds. Many good businesses were created in the late 1990s. At the same time many not even remotely viable businesses chewed up capital that could have been put to use elsewhere. The widespread mispricing (on the high side) of internet related businesses made it seem like easy money. Meanwhile, at the time, it's almost certain something non-internet related but more viable couldn't even get a return call from the distracted investment bankers and venture capitalists. That's why widespread mispricing in the capital markets makes bubbles so expensive and painful economically. Money gets burned up on bad investments while others are starved for capital. It may seem like a big party at the time but it is, in fact, very costly.
** Historically, the norm has been much longer.
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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.