The emergence of craft beers and microbrewers is changing the industry landscape.
According to this article, some executives in the the beer industry seem concerned that the beer business may eventually be dominated by local producers. In other words, sort of go the way of the wine industry.
The article has some useful information about how the global beer business has been changing:
- The four largest beer companies now have 55% of the beer market compared to 17% in 1999.
- Not surprisingly, operating margins have doubled for them with the added scale and reduced competition.
That's the good news. Here's the challenge:
- Consumer tastes in the U.S. & U.K. are changing in favor of craft brewers.
- Craft brewers have grown volumes by 9.8% per year over 5 years in the U.S., now have 6% market share.
- Mainstream beers volumes have been going the opposite direction...dropping more like 1.9% annually.
- The three biggest craft brewers command 35% of the craft beer market (excluding the craft brewers owned by the big players).
4 largest Beer Companies*
Anheuser-Busch InBev (BUD)
SABMiller (SBMRY)
Heineken (HINKY)
Carlsberg (CABGY)
Anheuser-Busch InBev, the biggest among these four, has a market cap of ~ $ 140 billion, revenue of ~ $ 40 billion, profit margin of 18 percent or so, and sells at roughly 20x current earnings.
It's a business that has a substantial economic moat but, unfortunately, not a cheap valuation.
Molson Coors (TAP) is smaller than the four above especially when compared to AB InBev. Its market cap is just under $ 8 billion but has less than 1/10th the earnings of AB InBev.
Molson Coors sells for a much more reasonable valuation but offers a narrower economic moat.
The article suggests all these changes are likely to put downward pressure on operating margins. Maybe so.
The big beer companies will have to respond to the changing industry dynamics and, at times, it may even be somewhat of a challenge for the big players to adapt. Buying the best of the microbreweries or developing more of their own craft beers in-house seems probable.
Having more brands may mean more costs for the but beer remains a business about scale and dominant distribution. So, considering the big picture from an investors perspective, I doubt this will end up putting a meaningful dent in the core long-term economics of the biggest industry players. I'd be surprised if they didn't produce very impressive returns on capital over the long haul.
I just wish their valuations would become a bit more attractive again.
The growth prospects may exist among the craft brewers and the best of them might even do more than just okay. Boston Beer Company (SAM) seems to have a pretty good shot at developing a nicely sustainable economic moat but the shares are far from inexpensive.
They may lack exciting growth prospects, but long run core economics of the widest moat big beer companies probably shouldn't be underestimated.
Consider that, before prohibition, the number of breweries in the U.S. peaked at 1,751 breweries.
By 1980, that number had fallen to less than 100 breweries.
In 2011, there were 1940 craft brewers according to the Brewers Association. So the changes to the industry have been pretty dramatic.
Adam
No position in the above stocks
Related posts:
Where The Growth Is In The Beer Industry
The Beer Industry's Bright Spot
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, October 3, 2012
Monday, October 1, 2012
Barron's Talks With David Winters
David Winters, founder of the Wintergreen Fund (WGRNX), was highlighted in a Barron's article this past weekend. From the article:
If you want to know what stocks David J. Winters likes, you can pore over his 13F filings or just look at his miniature train set.
It turns out Winters has a train set that has stops along the way to "honor" some of the positions he owns. For example there is:
...a chocolate factory whose smokestacks spew a sweet smell to reflect his Nestlé stake.
I suppose what makes this easier to do is the relatively low turnover of the fund.
(Otherwise, Winters would constantly be modifying that train set. Then again, all the tearing down/re-building is probably good fun if miniature trains happens to be your hobby.)
Nestlé is highlighted as the kind of stock that "epitomizes" what David Winters likes to own.
Top Ten Positions*
Jardine Matheson
British American Tobacco
Altria
Berkshire Hathaway
Swatch Group AG
Imperial Tobacco
Franklin Resources
Philp Morris Intl
Genting Malaysia
MasterCard
Source: Morningstar
These positions make up roughly 49 percent of the portfolio.
Nearly 20 percent of the portfolio is in shares of tobacco-related businesses. Tobacco businesses, at least those with strong brands and distribution, tend to produce above average returns. Understandably, not everyone likes to invest in an enterprise that has anything to do with selling tobacco products.
The low turnover approach and the many high quality businesses in the portfolio is impressive but it's worth noting that the expense ratio of the fund currently stands at 1.86 percent. Morningstar, not surprisingly, considers the fee level of this fund to be high.
The fees matter but it's good to see someone that primarily emphasizes producing returns via the partial ownership of great businesses (as their intrinsic value increases over time).
An emphasis on long-term effects (and the magic of compounding) not price action.
In my book his style of investing has real advantages. Well, especially when put up against the varied attempts by some market participants to consistently try to jump into and out of the "right" stocks and/or sectors (while somehow not making material mistakes and racking up huge transaction costs) at just the correct time.
Adam
* A number of the international stocks held in this fund have their primary listing on a stock exchange outside the United States. Some of these can be purchased via American Depository Receipts (ADR) on a U.S. exchange or the over-the-counter (OTC) market. The purchase of foreign ordinaries OTC and, of course, directly on a foreign exchange are also options. Some of these options create varying degrees of liquidity, informational, currency exposure, and many other challenges for the investor to say the least.
---
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.
If you want to know what stocks David J. Winters likes, you can pore over his 13F filings or just look at his miniature train set.
It turns out Winters has a train set that has stops along the way to "honor" some of the positions he owns. For example there is:
...a chocolate factory whose smokestacks spew a sweet smell to reflect his Nestlé stake.
I suppose what makes this easier to do is the relatively low turnover of the fund.
(Otherwise, Winters would constantly be modifying that train set. Then again, all the tearing down/re-building is probably good fun if miniature trains happens to be your hobby.)
Nestlé is highlighted as the kind of stock that "epitomizes" what David Winters likes to own.
Top Ten Positions*
Jardine Matheson
British American Tobacco
Altria
Berkshire Hathaway
Swatch Group AG
Imperial Tobacco
Franklin Resources
Philp Morris Intl
Genting Malaysia
MasterCard
Source: Morningstar
These positions make up roughly 49 percent of the portfolio.
Nearly 20 percent of the portfolio is in shares of tobacco-related businesses. Tobacco businesses, at least those with strong brands and distribution, tend to produce above average returns. Understandably, not everyone likes to invest in an enterprise that has anything to do with selling tobacco products.
The low turnover approach and the many high quality businesses in the portfolio is impressive but it's worth noting that the expense ratio of the fund currently stands at 1.86 percent. Morningstar, not surprisingly, considers the fee level of this fund to be high.
The fees matter but it's good to see someone that primarily emphasizes producing returns via the partial ownership of great businesses (as their intrinsic value increases over time).
An emphasis on long-term effects (and the magic of compounding) not price action.
In my book his style of investing has real advantages. Well, especially when put up against the varied attempts by some market participants to consistently try to jump into and out of the "right" stocks and/or sectors (while somehow not making material mistakes and racking up huge transaction costs) at just the correct time.
Adam
* A number of the international stocks held in this fund have their primary listing on a stock exchange outside the United States. Some of these can be purchased via American Depository Receipts (ADR) on a U.S. exchange or the over-the-counter (OTC) market. The purchase of foreign ordinaries OTC and, of course, directly on a foreign exchange are also options. Some of these options create varying degrees of liquidity, informational, currency exposure, and many other challenges for the investor to say the least.
---
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.
Friday, September 28, 2012
High-frequency Trading & Capital Formation
From this article on high-frequency trading:
High-frequency trading insanity
...the high-frequency trader, deploys massive computer capacity and complex algorithms to buy and sell individual stocks multiple times in a fraction of a second, all in search of micro-profits with each trade. This trader cares not a whit about a stock's fundamentals.
In a sane world, high-frequency trading would be a minor specialty at best. But in the bizarro world that Wall Street has become, such activity now makes up the majority of all trades. It is manufacturing risk while siphoning money and talent that growth-producing sectors of the economy need.
Then a bit later in the article:
...these practices undermine the core purpose of markets, which is to raise capital in pursuit of enterprise, profit and economic growth.
In his latest book, John Bogle points out that there are more than $ 30 trillion worth of trades each year, yet fresh investment of capital into things like businesses, new technology, medical breakthroughs, plant and equipment is less than 1/100th that amount (~ $ 250 billion). So our equity market system now has more than 99 percent speculation for less than every 1 percent of actual capital formation.*
With those numbers in mind, I don't think it's unfair to say we have more than enough liquidity. These traders, not surprisingly, don't quite see it that way.
The traders argue that they add liquidity to markets that lowers transaction costs and eases dealing in thinly traded shares. There is some truth to this. But the negatives far outweigh the positives.
It's certainly the case that markets need enough liquidity. I think it's safe to say we're well beyond having a shortage of liquidity when pieces of businesses are being bought and sold in fractions of a second over and over again.
We need an optimal amount, not an unlimited amount.
Eventually, more isn't better.
Once there's enough liquidity, the focus ought to be reducing the cost of capital and improving capital formation. Getting capital to where it is needed most to fund crucial investments.
Those who buy/sell in high volumes obviously benefit greatly when the cost of each transaction goes down. Those with a longer term horizon who trade infrequently the absolute minimization of transaction costs matters less. So the lowest possible transaction costs is naturally a top priority of a highly active trader. Yet market's don't exist to serve traders.
They exist to support the formation and development of enterprise in the real economy.
Equity markets are there (or should be) to help fund the creation and expansion of businesses. Naturally, low transaction costs and enough liquidity matters to a varying extent to all participants, but that focus is too narrow.
For businesses in pursuit of opportunity, lowering the cost of capital and enhancing access to capital is far more important.
My vote is for more emphasis on whether markets are structured to increase the probability that capital is directed to its highest and best use.
That dollars in enough scale are meeting up with good ideas and talent.
After all, that's the reason the equity markets exist in the first place. At the present time, there's more than enough liquidity. Transaction costs are hardly at levels that hinder progress in the real economy.
If all this added liquidity is actually lowering the cost of capital then it's a useful thing. If, instead, it is creating added volatility, as it surely seems to be, and instability (perceived, real, or a little of both...fear of the next flash crash when some unforeseen scary macro event inevitably occurs), then it has the potential to raise the cost of capital if participants who might otherwise put their capital at risk are less willing to do so.
Liquidity is also a good thing as it helps to generally set market prices closer to the per share intrinsic value of the underlying businesses. Frequent and substantial mispricing ultimately leads to capital misallocation. Well, if as the article above suggests, the high-frequency variety of trader "cares not a whit about a stock's fundamentals," and that their activity "now makes up the majority of all trades," it seems unlikely they'll make a useful contribution to the discovery of a fundamentally rational market price relative to per share intrinsic business value.**
(Realistically, it would always be more a range of prices. It's not like wide fluctuations could ever be eliminated in the equity markets. The simple reason being that there's no way to ever perfectly judge what intrinsic per share business value actually is. The range is necessarily especially wide for shares of certain more speculative businesses.)
So, at least in today's market, apparently the bulk of all trading comes from those basically uninterested in underlying business fundamentals.
With so few interested in underlying fundamentals, how do we not end up with stocks becoming mispriced more often in that environment? How do you not end up with a market environment where capital is frequently misallocated?
Most answers to those two questions seem destined to be, at best, rather contorted.
(Though those with enough creativity, motivation, and vested interest in the status quo could no doubt come up with a good way to answer these questions.)
The markets exist to help facilitate capital formation for businesses so they can more ably pursue productive enterprise. Markets operate below their potential when they become a hyperactive, casino-like, atmosphere more interested in serving its active participants (those primary interest is near-term price action) instead of the entities that need capital to fund their opportunities.
I'd like to see some evidence that high-frequency trading makes it easier for corporations to efficiently raise capital and/or that it lowers the cost of that capital. It seems likely that all this added hyperactivity does little in that regard and, instead, mostly just adds a bunch of frictional costs to the system as a whole (even if it happens to lower the cost for certain participants.)
Those costs are effectively a tax on capital formation. Yet the biggest cost might be all the talent high-frequency trading takes away from more value added endeavors.
Here's a report by the Federal Reserve Bank of Chicago for more background on the concerns surrounding high-speed trading and keeping markets safe. Also, last week a senate panel looked into this.
Washington Post: Senate panel looks into high-frequency stock trades
According to this article, the Federal Reserve has concerns about how market structure is impacting their easing policies. Programs like quantitative easing depend on the markets functioning well.
Finally, the SEC is supposed to hold a meeting next week on this in an attempt to figure out just what to do about it.
I'd prefer to think otherwise but it doesn't seem likely much of this will be fixed anytime soon.
Adam
* In this essay, John Bogle cites slightly different numbers. He says that annual stock trading volume is $ 30 trillion while average annual new issues of common stock is $ 145 billion. So trading represents more than 200x the amount of equity capital that's provided to businesses.
** I personally like it when stocks get mispriced but frequent and substantial mispricing ultimately leads to capital misallocation. So I'm speaking in terms of what's the best way for equity markets to promote enterprise not how to make life easier for participants who seek out mispricing in the equity markets.
---
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.
High-frequency trading insanity
...the high-frequency trader, deploys massive computer capacity and complex algorithms to buy and sell individual stocks multiple times in a fraction of a second, all in search of micro-profits with each trade. This trader cares not a whit about a stock's fundamentals.
In a sane world, high-frequency trading would be a minor specialty at best. But in the bizarro world that Wall Street has become, such activity now makes up the majority of all trades. It is manufacturing risk while siphoning money and talent that growth-producing sectors of the economy need.
Then a bit later in the article:
...these practices undermine the core purpose of markets, which is to raise capital in pursuit of enterprise, profit and economic growth.
In his latest book, John Bogle points out that there are more than $ 30 trillion worth of trades each year, yet fresh investment of capital into things like businesses, new technology, medical breakthroughs, plant and equipment is less than 1/100th that amount (~ $ 250 billion). So our equity market system now has more than 99 percent speculation for less than every 1 percent of actual capital formation.*
With those numbers in mind, I don't think it's unfair to say we have more than enough liquidity. These traders, not surprisingly, don't quite see it that way.
The traders argue that they add liquidity to markets that lowers transaction costs and eases dealing in thinly traded shares. There is some truth to this. But the negatives far outweigh the positives.
It's certainly the case that markets need enough liquidity. I think it's safe to say we're well beyond having a shortage of liquidity when pieces of businesses are being bought and sold in fractions of a second over and over again.
We need an optimal amount, not an unlimited amount.
Eventually, more isn't better.
Once there's enough liquidity, the focus ought to be reducing the cost of capital and improving capital formation. Getting capital to where it is needed most to fund crucial investments.
Those who buy/sell in high volumes obviously benefit greatly when the cost of each transaction goes down. Those with a longer term horizon who trade infrequently the absolute minimization of transaction costs matters less. So the lowest possible transaction costs is naturally a top priority of a highly active trader. Yet market's don't exist to serve traders.
They exist to support the formation and development of enterprise in the real economy.
Equity markets are there (or should be) to help fund the creation and expansion of businesses. Naturally, low transaction costs and enough liquidity matters to a varying extent to all participants, but that focus is too narrow.
For businesses in pursuit of opportunity, lowering the cost of capital and enhancing access to capital is far more important.
My vote is for more emphasis on whether markets are structured to increase the probability that capital is directed to its highest and best use.
That dollars in enough scale are meeting up with good ideas and talent.
After all, that's the reason the equity markets exist in the first place. At the present time, there's more than enough liquidity. Transaction costs are hardly at levels that hinder progress in the real economy.
If all this added liquidity is actually lowering the cost of capital then it's a useful thing. If, instead, it is creating added volatility, as it surely seems to be, and instability (perceived, real, or a little of both...fear of the next flash crash when some unforeseen scary macro event inevitably occurs), then it has the potential to raise the cost of capital if participants who might otherwise put their capital at risk are less willing to do so.
Liquidity is also a good thing as it helps to generally set market prices closer to the per share intrinsic value of the underlying businesses. Frequent and substantial mispricing ultimately leads to capital misallocation. Well, if as the article above suggests, the high-frequency variety of trader "cares not a whit about a stock's fundamentals," and that their activity "now makes up the majority of all trades," it seems unlikely they'll make a useful contribution to the discovery of a fundamentally rational market price relative to per share intrinsic business value.**
(Realistically, it would always be more a range of prices. It's not like wide fluctuations could ever be eliminated in the equity markets. The simple reason being that there's no way to ever perfectly judge what intrinsic per share business value actually is. The range is necessarily especially wide for shares of certain more speculative businesses.)
So, at least in today's market, apparently the bulk of all trading comes from those basically uninterested in underlying business fundamentals.
With so few interested in underlying fundamentals, how do we not end up with stocks becoming mispriced more often in that environment? How do you not end up with a market environment where capital is frequently misallocated?
Most answers to those two questions seem destined to be, at best, rather contorted.
(Though those with enough creativity, motivation, and vested interest in the status quo could no doubt come up with a good way to answer these questions.)
The markets exist to help facilitate capital formation for businesses so they can more ably pursue productive enterprise. Markets operate below their potential when they become a hyperactive, casino-like, atmosphere more interested in serving its active participants (those primary interest is near-term price action) instead of the entities that need capital to fund their opportunities.
I'd like to see some evidence that high-frequency trading makes it easier for corporations to efficiently raise capital and/or that it lowers the cost of that capital. It seems likely that all this added hyperactivity does little in that regard and, instead, mostly just adds a bunch of frictional costs to the system as a whole (even if it happens to lower the cost for certain participants.)
Those costs are effectively a tax on capital formation. Yet the biggest cost might be all the talent high-frequency trading takes away from more value added endeavors.
Here's a report by the Federal Reserve Bank of Chicago for more background on the concerns surrounding high-speed trading and keeping markets safe. Also, last week a senate panel looked into this.
Washington Post: Senate panel looks into high-frequency stock trades
According to this article, the Federal Reserve has concerns about how market structure is impacting their easing policies. Programs like quantitative easing depend on the markets functioning well.
Finally, the SEC is supposed to hold a meeting next week on this in an attempt to figure out just what to do about it.
I'd prefer to think otherwise but it doesn't seem likely much of this will be fixed anytime soon.
Adam
* In this essay, John Bogle cites slightly different numbers. He says that annual stock trading volume is $ 30 trillion while average annual new issues of common stock is $ 145 billion. So trading represents more than 200x the amount of equity capital that's provided to businesses.
** I personally like it when stocks get mispriced but frequent and substantial mispricing ultimately leads to capital misallocation. So I'm speaking in terms of what's the best way for equity markets to promote enterprise not how to make life easier for participants who seek out mispricing in the equity markets.
---
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, September 26, 2012
Second Quarter Stock Buybacks Rise
This recent S&P Dow Jones Indices press release summarizes share repurchases for the second quarter among the companies that make up the S&P 500.
According to the press release, there have been $ 788 billion in buybacks by the following 20 companies since the 4th quarter of 2004. In fact, there has been $ 2.81 trillion in buybacks by all the companies in the S&P 500 over that same time frame.
A rather impressively large number to say the least.*
Here's the twenty largest 2nd quarter buybacks:
- Johnson & Johnson (JNJ) $12.85 billion
- Exxon Mobil (XOM) $5.01 billion
- ConocoPhillips (COP) $3.05 billion
- Intl Business Machines (IBM) $2.99 billion
- AT&T (T) $2.56 billion
- Oracle (ORCL) $2.40 billion
- Wells Fargo & Company (WFC) $2.04 billion
- American International Group (AIG) $2.00 billion
- Cisco Systems (CSCO) $1.89 billion
- Wal-Mart Stores (WMT) $1.84
- American Express (AXP) $1.78 billion
- Philip Morris International (PM) $1.63 billion
- The Coca-Cola Company (KO) $1.53 billion
- The Goldman Sachs Group (GS) $1.50 billion
- The Home Depot (HD) $1.50 billion
- JP Morgan Chase & Co (JPM) $1.44 billion
- Intel Corporation (INTC) $1.40 billion
- DIRECTV (DTV) $1.35 billion
- Pfizer (PFE) $1.34 billion
- News Corporation (NWSA) $1.30 billion
During the quarter, the top 20 bought back $51.39 billion while all companies in the S&P 500 combined bought back $ 111.75 billion.
J&J's buyback comes as part of a deal to buy Synthes for roughly $ 20 billion that is summarized here. It's the biggest deal in the company's 126 year history and was financed with roughly 65 percent stock and 35 percent cash.
This 8-K filing provides more details. Essentially, they are using foreign cash held at an Irish subsidiary (Janssen Pharmaceutical) to buy back $ 12.9 billion of J&J's shares.
This J&J press release to announce U.S. regulatory clearance for the deal also explains the financing of this transaction.
Janssen Pharmaceutical, a wholly owned Irish subsidiary of Johnson & Johnson, has entered into accelerated share repurchase (ASR) agreements with Goldman, Sachs & Co. and JPMorgan Chase Bank, N.A. to purchase a combined total of 203.7 million shares of Johnson & Johnson common stock for an initial purchase price of $12.9 billion.
Here's how the deal is financed. Those shares bought via the ASR agreements along with cash on hand at the subsidiary will then be given as merger consideration to Synthes shareholders. So, unlike most other buybacks, it's not as if this one by J&J is going to result in a reduction in share count. It's simply going to prevent the share count from going up as a result of the transaction.
The reason for the financial gymnastics is to prevent a big U.S. tax bill.
The ConocoPhillips buyback may not have been the biggest in dollar terms but, if their buyback rate continued for an entire year, it would amount to 17 percent of Conoco's current market value. In fact, DIRECTV, AIG, AmEx, and Goldman Sachs all were buying back at an annualized rate that, if continued for a full year, would represent 10 percent or more of their current market value.**
Obviously, these companies may not necessarily continue to buy back at the same rates (nor should they if the share price doesn't represent a nice discount to value) but these actions do represent impressive proportions of total market value. Naturally, when the price drops a larger number of shares can be bought back for the same amount of cash. Unfortunately, these stocks are not nearly as cheap as they were not all that long ago. The inevitable, arithmetically certain, outcome being that these buybacks would be even more effective if they were still at or near those lower valuations.
So a long-term investor shouldn't generally want shares of a sound business they own to go up in the near-term. What's an exception to this? Here's one scenario to consider. Unfortunately, there's the very real risk that 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.
Otherwise, a long-term investor (who judges intrinsic value well, of course) should generally want the price to go down in the near-term or even longer. Warren Buffett provides a useful explanation of this using IBM as an example in the 2011 Berkshire Hathaway (BRKa) Shareholder Letter. Also, here's a prior post on the same subject:
Why Buffett Wants IBM's Shares "To Languish"
That's why it matters a whole lot for a high proportion of the board, management, and other owners (especially those who are influential) of the stock have potential long-term value creation over short-term gains in mind.
That's why it matters if there are fewer traders and more true long-term owners controlling the shares outstanding.
It's also why it matters that long-term prospects are well understood by the board, management, and owners even if real short-term challenges have pressured the stock price. All of this must be carefully considered by an investor.
Adam
* Unfortunately a disproportionate amount was done throughout 2007 and early 2008 when the market was at or near its peak. So the fact that buybacks have risen recently hardly says much about where stocks are going in the near-term and even longer. Buybacks only makes sense when shares sell below intrinsic value, the company is otherwise well-financed, and the investments needed to maintain/increase competitiveness can still be made. Ideally, buybacks should (and actually would) mostly occur when the discount to value is clear and substantial.
** The annualized buy back rate for DIRECTV would be equal to 16 percent of current market value. AIG = ~ 14 percent. AmEx = ~ 11 percent. Goldman Sachs = ~ 10 percent. AIG's buybacks, of course, follow the massive dilution that occurred to the company's share count during the financial crisis.
Johnson & Johnson and Synthes Announce Definitive Merger Agreement - 8-K Filing
Johnson & Johnson Announces Completion of Synthes Acquisition - 8-K Filing
Keywords: Buyout below value, going private below value, premium to market value but discount to intrinsic value.
---
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.
According to the press release, there have been $ 788 billion in buybacks by the following 20 companies since the 4th quarter of 2004. In fact, there has been $ 2.81 trillion in buybacks by all the companies in the S&P 500 over that same time frame.
A rather impressively large number to say the least.*
Here's the twenty largest 2nd quarter buybacks:
- Johnson & Johnson (JNJ) $12.85 billion
- Exxon Mobil (XOM) $5.01 billion
- ConocoPhillips (COP) $3.05 billion
- Intl Business Machines (IBM) $2.99 billion
- AT&T (T) $2.56 billion
- Oracle (ORCL) $2.40 billion
- Wells Fargo & Company (WFC) $2.04 billion
- American International Group (AIG) $2.00 billion
- Cisco Systems (CSCO) $1.89 billion
- Wal-Mart Stores (WMT) $1.84
- American Express (AXP) $1.78 billion
- Philip Morris International (PM) $1.63 billion
- The Coca-Cola Company (KO) $1.53 billion
- The Goldman Sachs Group (GS) $1.50 billion
- The Home Depot (HD) $1.50 billion
- JP Morgan Chase & Co (JPM) $1.44 billion
- Intel Corporation (INTC) $1.40 billion
- DIRECTV (DTV) $1.35 billion
- Pfizer (PFE) $1.34 billion
- News Corporation (NWSA) $1.30 billion
During the quarter, the top 20 bought back $51.39 billion while all companies in the S&P 500 combined bought back $ 111.75 billion.
J&J's buyback comes as part of a deal to buy Synthes for roughly $ 20 billion that is summarized here. It's the biggest deal in the company's 126 year history and was financed with roughly 65 percent stock and 35 percent cash.
This 8-K filing provides more details. Essentially, they are using foreign cash held at an Irish subsidiary (Janssen Pharmaceutical) to buy back $ 12.9 billion of J&J's shares.
This J&J press release to announce U.S. regulatory clearance for the deal also explains the financing of this transaction.
Janssen Pharmaceutical, a wholly owned Irish subsidiary of Johnson & Johnson, has entered into accelerated share repurchase (ASR) agreements with Goldman, Sachs & Co. and JPMorgan Chase Bank, N.A. to purchase a combined total of 203.7 million shares of Johnson & Johnson common stock for an initial purchase price of $12.9 billion.
Here's how the deal is financed. Those shares bought via the ASR agreements along with cash on hand at the subsidiary will then be given as merger consideration to Synthes shareholders. So, unlike most other buybacks, it's not as if this one by J&J is going to result in a reduction in share count. It's simply going to prevent the share count from going up as a result of the transaction.
The reason for the financial gymnastics is to prevent a big U.S. tax bill.
The ConocoPhillips buyback may not have been the biggest in dollar terms but, if their buyback rate continued for an entire year, it would amount to 17 percent of Conoco's current market value. In fact, DIRECTV, AIG, AmEx, and Goldman Sachs all were buying back at an annualized rate that, if continued for a full year, would represent 10 percent or more of their current market value.**
Obviously, these companies may not necessarily continue to buy back at the same rates (nor should they if the share price doesn't represent a nice discount to value) but these actions do represent impressive proportions of total market value. Naturally, when the price drops a larger number of shares can be bought back for the same amount of cash. Unfortunately, these stocks are not nearly as cheap as they were not all that long ago. The inevitable, arithmetically certain, outcome being that these buybacks would be even more effective if they were still at or near those lower valuations.
So a long-term investor shouldn't generally want shares of a sound business they own to go up in the near-term. What's an exception to this? Here's one scenario to consider. Unfortunately, there's the very real risk that 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.
Otherwise, a long-term investor (who judges intrinsic value well, of course) should generally want the price to go down in the near-term or even longer. Warren Buffett provides a useful explanation of this using IBM as an example in the 2011 Berkshire Hathaway (BRKa) Shareholder Letter. Also, here's a prior post on the same subject:
Why Buffett Wants IBM's Shares "To Languish"
That's why it matters a whole lot for a high proportion of the board, management, and other owners (especially those who are influential) of the stock have potential long-term value creation over short-term gains in mind.
That's why it matters if there are fewer traders and more true long-term owners controlling the shares outstanding.
It's also why it matters that long-term prospects are well understood by the board, management, and owners even if real short-term challenges have pressured the stock price. All of this must be carefully considered by an investor.
Adam
* Unfortunately a disproportionate amount was done throughout 2007 and early 2008 when the market was at or near its peak. So the fact that buybacks have risen recently hardly says much about where stocks are going in the near-term and even longer. Buybacks only makes sense when shares sell below intrinsic value, the company is otherwise well-financed, and the investments needed to maintain/increase competitiveness can still be made. Ideally, buybacks should (and actually would) mostly occur when the discount to value is clear and substantial.
** The annualized buy back rate for DIRECTV would be equal to 16 percent of current market value. AIG = ~ 14 percent. AmEx = ~ 11 percent. Goldman Sachs = ~ 10 percent. AIG's buybacks, of course, follow the massive dilution that occurred to the company's share count during the financial crisis.
Johnson & Johnson and Synthes Announce Definitive Merger Agreement - 8-K Filing
Johnson & Johnson Announces Completion of Synthes Acquisition - 8-K Filing
Keywords: Buyout below value, going private below value, premium to market value but discount to intrinsic value.
---
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, September 24, 2012
Sheila Bair: Former FDIC Chair on the Bank Bailouts
Sheila Bair, chairman of the FDIC throughout the financial crisis, has a new book with the following title:
Bull by the Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself
She led the FDIC from June 2006 through July 2011 and has a uniquely close up view of what actually happened. Fortune recently published an excerpt from the new book. There's some rather interesting and blunt insights in the excerpt. Well worth reading in its entirety.
In the excerpt, Bair describes the meeting with bankers that occurred at the Treasury Department back in October of 2008. In that meeting, Treasury Secretary Hank Paulson convinced a roomful of bank CEOs to go along with the TARP bailout.
Here's some examples of Sheila Bair's insights about the meeting:
On Richard Kovacevich, Chairman*, at the time, of Wells Fargo (WFC)
He [Kovacevich] was eager to give me an update on his bank's acquisition of Wachovia, which...I had helped facilitate. Kovacevich could be rude and abrupt, but he and his bank were very good at managing their business and executing on deals. I had no doubt that their acquisition of Wachovia would be completed smoothly and without disruption...
At the time, Wells Fargo had recently come in with a deal for Wachovia that derailed Citigroup's (C) plans to buy the troubled bank. Citigroup needed help from the FDIC to pull it off. Wells Fargo did not. Citigroup's CEO Vikram Pandit naturally didn't appreciate what Wells had done and was not happy with the fact that Bair had been supportive of their deal over Citigroup's.**
Bair says she didn't have much choice.
Wells was a much stronger, better-managed bank and could buy Wachovia without help from us.
Basically, the FDIC didn't need two troubled banks to merge when a relatively healthy and well run bank like Wells Fargo was more than capable of doing it, and could handle the job on its own.
On Vikram Pandit, CEO of Citigroup
Pandit looked nervous, and no wonder. More than any other institution represented in that room, his bank was in trouble. Frankly, I doubted that he was up to the job.
On Kenneth Lewis, CEO (at the time) of Bank of America (BAC)
He was viewed somewhat as a country bumpkin by the CEOs of the big New York banks, and not completely without justification. He was a decent traditional banker, but as a dealmaker his skills were clearly wanting...
By doing expensive dumb deals for two very sick financial institutions, Merrill Lynch and Countrywide, he took BofA, a bank that was healthy going into the crisis, and turned it into one that was very much less so.
Bair goes on to say that the actions of others were smarter with the smartest being Jamie Dimon...
On Jamie Dimon, CEO of J.P. Morgan Chase (JPM)
Dimon was a towering figure in height as well as leadership ability.
She says that Dimon had warned of troubles in subprime early on and protected his bank via preemptive actions prior to the crisis:
As a consequence, while other institutions were reeling, mighty J.P. Morgan Chase had scooped up weaker institutions at bargain prices.
The purpose of this meeting at the Treasury Department was for Paulson to tell this group of bankers they had to, at least temporarily, accept government capital. In addition to the capital injection, the FDIC was asked to temporarily guarantee the debt of these institutions, while the Fed would be opening up special lending programs measured in trillions of dollars.
Here's some other noteworthy insights of what occurred during the meeting:
- John Thain, the CEO of Merrill Lynch (who Bair earlier in the excerpt described as insolvent), apparently was concerned about executive compensation.
Sheila Bair: I couldn't believe it. Where were the guy's priorities?
- BofA's Kenneth Lewis agreed to participate in the program and thought talking about compensation wasn't appropriate.
- Vikram Pandit apparently scribbled some numbers down then said "This is cheap capital".
(Treasury was only asking for a 5 percent dividend on the capital. Citi would likely not have been able to get anything like that kind of cheap funding elsewhere.)
Sheila Bair: I wondered what kind of calculations he needed to make to figure that out.
- Richard Kovacevich complained, rightfully in Bair's view, that Wells Fargo didn't need the capital.
Sheila Bair: I was astonished when Hank shot back that his regulator might have something to say about whether Wells' capital was adequate if he didn't take the money.
- Jamie Dimon also said J.P. Morgan Chase didn't need the money but accepted it for the sake of system stability. Other CEOs apparently followed with similar sentiments.
By the end of the day each bank had agreed to accept the money.
Sheila Bair says that Citigroup probably needed the government assistance. Otherwise, she seems to think that the capital levels at the other large commercial banks were adequate. So the capital injections into those firms, at least according to her, were largely unnecessary.
The investment banks were in trouble but she also questions whether they needed the capital injections.
Yet, since Merrill was to be acquired by Bank of America (who paid a generous price to say the least), while Goldman and Morgan had been able to raise capital privately (and she thinks were capable of raising more as needed), she also questions whether the capital was actually needed.
It was, of course, a chaotic environment during the crisis.
Decisions without all the necessary information had to be made.
Bair admits that these actions collectively were a success in the sense that the system didn't fall apart, but wonders what the real costs of not imposing more discipline on the worst actors might be down the road.
Check out the entire excerpt in Fortune.
Adam
* John Stumpf became Chairman of Well Fargo in January of 2010.
** Nor did Timothy Geithner who was the head of the New York Federal Reserve Bank and Citigroup's primary regulator. Bair says that both Pandit and Geithner were angry with her for not objecting to the Wells acquisition.
---
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.
Bull by the Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself
She led the FDIC from June 2006 through July 2011 and has a uniquely close up view of what actually happened. Fortune recently published an excerpt from the new book. There's some rather interesting and blunt insights in the excerpt. Well worth reading in its entirety.
In the excerpt, Bair describes the meeting with bankers that occurred at the Treasury Department back in October of 2008. In that meeting, Treasury Secretary Hank Paulson convinced a roomful of bank CEOs to go along with the TARP bailout.
Here's some examples of Sheila Bair's insights about the meeting:
On Richard Kovacevich, Chairman*, at the time, of Wells Fargo (WFC)
He [Kovacevich] was eager to give me an update on his bank's acquisition of Wachovia, which...I had helped facilitate. Kovacevich could be rude and abrupt, but he and his bank were very good at managing their business and executing on deals. I had no doubt that their acquisition of Wachovia would be completed smoothly and without disruption...
At the time, Wells Fargo had recently come in with a deal for Wachovia that derailed Citigroup's (C) plans to buy the troubled bank. Citigroup needed help from the FDIC to pull it off. Wells Fargo did not. Citigroup's CEO Vikram Pandit naturally didn't appreciate what Wells had done and was not happy with the fact that Bair had been supportive of their deal over Citigroup's.**
Bair says she didn't have much choice.
Wells was a much stronger, better-managed bank and could buy Wachovia without help from us.
Basically, the FDIC didn't need two troubled banks to merge when a relatively healthy and well run bank like Wells Fargo was more than capable of doing it, and could handle the job on its own.
On Vikram Pandit, CEO of Citigroup
Pandit looked nervous, and no wonder. More than any other institution represented in that room, his bank was in trouble. Frankly, I doubted that he was up to the job.
On Kenneth Lewis, CEO (at the time) of Bank of America (BAC)
He was viewed somewhat as a country bumpkin by the CEOs of the big New York banks, and not completely without justification. He was a decent traditional banker, but as a dealmaker his skills were clearly wanting...
By doing expensive dumb deals for two very sick financial institutions, Merrill Lynch and Countrywide, he took BofA, a bank that was healthy going into the crisis, and turned it into one that was very much less so.
Bair goes on to say that the actions of others were smarter with the smartest being Jamie Dimon...
On Jamie Dimon, CEO of J.P. Morgan Chase (JPM)
Dimon was a towering figure in height as well as leadership ability.
She says that Dimon had warned of troubles in subprime early on and protected his bank via preemptive actions prior to the crisis:
As a consequence, while other institutions were reeling, mighty J.P. Morgan Chase had scooped up weaker institutions at bargain prices.
The purpose of this meeting at the Treasury Department was for Paulson to tell this group of bankers they had to, at least temporarily, accept government capital. In addition to the capital injection, the FDIC was asked to temporarily guarantee the debt of these institutions, while the Fed would be opening up special lending programs measured in trillions of dollars.
Here's some other noteworthy insights of what occurred during the meeting:
- John Thain, the CEO of Merrill Lynch (who Bair earlier in the excerpt described as insolvent), apparently was concerned about executive compensation.
Sheila Bair: I couldn't believe it. Where were the guy's priorities?
- BofA's Kenneth Lewis agreed to participate in the program and thought talking about compensation wasn't appropriate.
- Vikram Pandit apparently scribbled some numbers down then said "This is cheap capital".
(Treasury was only asking for a 5 percent dividend on the capital. Citi would likely not have been able to get anything like that kind of cheap funding elsewhere.)
Sheila Bair: I wondered what kind of calculations he needed to make to figure that out.
- Richard Kovacevich complained, rightfully in Bair's view, that Wells Fargo didn't need the capital.
Sheila Bair: I was astonished when Hank shot back that his regulator might have something to say about whether Wells' capital was adequate if he didn't take the money.
- Jamie Dimon also said J.P. Morgan Chase didn't need the money but accepted it for the sake of system stability. Other CEOs apparently followed with similar sentiments.
By the end of the day each bank had agreed to accept the money.
Sheila Bair says that Citigroup probably needed the government assistance. Otherwise, she seems to think that the capital levels at the other large commercial banks were adequate. So the capital injections into those firms, at least according to her, were largely unnecessary.
The investment banks were in trouble but she also questions whether they needed the capital injections.
Yet, since Merrill was to be acquired by Bank of America (who paid a generous price to say the least), while Goldman and Morgan had been able to raise capital privately (and she thinks were capable of raising more as needed), she also questions whether the capital was actually needed.
It was, of course, a chaotic environment during the crisis.
Decisions without all the necessary information had to be made.
Bair admits that these actions collectively were a success in the sense that the system didn't fall apart, but wonders what the real costs of not imposing more discipline on the worst actors might be down the road.
Check out the entire excerpt in Fortune.
Adam
* John Stumpf became Chairman of Well Fargo in January of 2010.
** Nor did Timothy Geithner who was the head of the New York Federal Reserve Bank and Citigroup's primary regulator. Bair says that both Pandit and Geithner were angry with her for not objecting to the Wells acquisition.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, September 21, 2012
Mason Hawkins: Competitively Advantaged Businesses Selling at a Discount to Value
Mason Hawkins, chairman and CEO of Southeastern Asset Management, the advisor to Longleaf Partner Funds, recently answered questions from GuruFocus readers.
Here is a quick summary of just a few of the noteworthy things he had to say:
- They look for financially strong, competitively entrenched/advantaged businesses selling at a significant discount to intrinsic value.
- They like to limit their portfolio to 20 investments and consider that number of securities adequate diversification. In fact, Mason Hawkins says statistical evidence shows there is little incremental benefit of additional holdings beyond 14 different stocks in different industries.
- They like owning businesses run by management that is competent both operationally and in terms of capital allocation.
Check out the Q&A in its entirety.
An excerpt:
"We view quality through the lens of a business owner. We want to own companies with the following qualitative characteristics. 1) Unique assets having distinct and sustainable competitive advantages that enable pricing power, long-term earnings growth, and stable or increasing profit margins. 2) High returns on capital and on equity as measured by free cash flow rather than earnings. 3) Capable management teams with operating skills, capital allocation prowess, and properly aligned, ownership-based incentives."
Hawkins also said that that their long-term horizon allows them to buy quality businesses at large discounts to value when earnings, for any number of reasons, happen to be reduced short-term. It's not a small advantage to be thinking a number of years out when so many market participants are focused on very near-term price dynamics.
In The Superinvestors of Graham-and-Doddsville, Warren Buffett made the following point about the "intellectual origin" of "superinvestors":*
"In addition to geographical origins, there can be what I call an intellectual origin."
He then adds that, in the world of investing, you'll find that a disproportionate number of successful investors...
"...came from a very small intellectual village that could be called Graham-and-Doddsville."
Buffett considers Ben Graham the "intellectual patriarch" with each successful investor applying or building upon the the theory in his own manner. Yet, while each may put the fundamental ideas of Graham-and-Dodd to work in somewhat different ways, they have a crucial thing in common:
"The patriarch has merely set forth the intellectual theory...but each student has decided on his own manner of applying the theory.
The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market."
Many market participants expend lots of energy figuring out (or attempting to) what direction a stock price might move in the near-term (or even the intermediate-term) and try to profit from it. It's fine and even necessary that some participants are involved in that sort of thing (though I do think the proportion who speculative versus invest longer term has become a bit extreme in favor of speculation).
The emphasis of a speculator is the correct judgment of relatively near-term price action.
The emphasis of an investor is judging value and how compounding effects will impact that value -- generally over a much longer time horizon -- then paying a price now that will produce a good result if that judgment turns out to be sound.
The price paid also must provide a margin of safety for the unforeseen and unforeseeable.
I think it is safe to say that those who primarily focus on making correct judgments about price action, especially those with an average holding period shorter than 3 to 5 years, are probably less influenced by Graham and Dodd and the many investors that have since built upon their theoretical framework.
There are exceptions, of course, but discrepancies between business value and price mostly need to play out over many years. Near-term price action are just votes that, in the near-term, reveal not much about how the price/value discrepancy will be resolved.
The hard work for those heavily influenced by Graham and Dodd is in figuring out what something is worth not trying to figure out what the stock will do. The stock will generally do just fine in the long run if business value was judged well.
Buffett later went on to say...
"Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value."
Well, Mason Hawkins and his team seem also very much focused on the variables of price and value. In one of his answers, Hawkins mentioned that they have...
"...a master list of appraisals for 600+ good businesses that we would like to own at the right price."
That's a rather expansive "master list" yet they still end up with a nicely concentrated portfolio when it's all said and done. In my view, owning shares in fewer businesses for a very long time means that big surprises become less likely over time as familiarity with the business and industry grows. So, as a result, there's less chance of getting the valuation very wrong. So my own preference happens to be owning fewer quality businesses for a very long time.***
While that may work for me it is just one of many ways to go about it.
Searching for discrepancies between price and value is the common theme but the specific approach for each investor is necessarily not one size fits all.
There's a wide range of effective ways to get results. For example, Walter Schloss, one of the 'superinvestors", often had a rather large number of stocks in his portfolio. His style is very much unlike Warren Buffett's and Charlie Munger's strong preference for portfolio concentration. It's not unusual for the Berkshire Hathaway (BRKa) equity portfolio to have 60-70 percent and, at times, even more allocated to just five stocks.
Like anything else, the best approach is consistent with individual limits and capabilities, realistically assessed, instead of wishful thinking or overconfidence.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Some might prefer more or less diversification.
Others may be a bit more or less active.
Maybe a particular knowledge or expertise lends itself to investing in certain types of businesses or industries.
The list goes on.
There are many variations always come back to the common theme of a focus on two variables: price and value.
Adam
* The "superinvestors" mentioned by Warren Buffett include: Walter Scloss, Tom Knapp (Tweedy Browne), Ed Anderson (Tweedy Browne), Bill Ruane (Sequoia Fund) , Rick Guerin, Stan Perlmeter and, of course, Charlie Munger (plus two funds managed by multiple managers).
** That doesn't mean those participants who may be generally more price action conscious don't, at times, use valuation as part of the justification for their trades. Market participants of all kinds draw from a variety of influences.
*** It's an approach that starts and ends with recognition of my own limits. Lower portfolio turnover, higher portfolio concentration, and generating returns primarily from increases to per share intrinsic value of the businesses themselves over time is what has worked best. Beyond the benefits of lower frictional costs, less moves means fewer mistakes. So, as a result, I buy the shares of a limited number of high quality businesses -- those I find understandable that are run by capable owner-oriented executives -- whenever they sell at a plain discount to my estimate of value. From there it is mostly about waiting as long as necessary for the right price then, when the price is right, buying a meaningful amount with the intent to hold long-term.
The Superinvestors of Graham-and-Doddsville
---
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.
Here is a quick summary of just a few of the noteworthy things he had to say:
- They look for financially strong, competitively entrenched/advantaged businesses selling at a significant discount to intrinsic value.
- They like to limit their portfolio to 20 investments and consider that number of securities adequate diversification. In fact, Mason Hawkins says statistical evidence shows there is little incremental benefit of additional holdings beyond 14 different stocks in different industries.
- They like owning businesses run by management that is competent both operationally and in terms of capital allocation.
Check out the Q&A in its entirety.
An excerpt:
"We view quality through the lens of a business owner. We want to own companies with the following qualitative characteristics. 1) Unique assets having distinct and sustainable competitive advantages that enable pricing power, long-term earnings growth, and stable or increasing profit margins. 2) High returns on capital and on equity as measured by free cash flow rather than earnings. 3) Capable management teams with operating skills, capital allocation prowess, and properly aligned, ownership-based incentives."
Hawkins also said that that their long-term horizon allows them to buy quality businesses at large discounts to value when earnings, for any number of reasons, happen to be reduced short-term. It's not a small advantage to be thinking a number of years out when so many market participants are focused on very near-term price dynamics.
In The Superinvestors of Graham-and-Doddsville, Warren Buffett made the following point about the "intellectual origin" of "superinvestors":*
"In addition to geographical origins, there can be what I call an intellectual origin."
He then adds that, in the world of investing, you'll find that a disproportionate number of successful investors...
"...came from a very small intellectual village that could be called Graham-and-Doddsville."
Buffett considers Ben Graham the "intellectual patriarch" with each successful investor applying or building upon the the theory in his own manner. Yet, while each may put the fundamental ideas of Graham-and-Dodd to work in somewhat different ways, they have a crucial thing in common:
"The patriarch has merely set forth the intellectual theory...but each student has decided on his own manner of applying the theory.
The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market."
Many market participants expend lots of energy figuring out (or attempting to) what direction a stock price might move in the near-term (or even the intermediate-term) and try to profit from it. It's fine and even necessary that some participants are involved in that sort of thing (though I do think the proportion who speculative versus invest longer term has become a bit extreme in favor of speculation).
The emphasis of a speculator is the correct judgment of relatively near-term price action.
The emphasis of an investor is judging value and how compounding effects will impact that value -- generally over a much longer time horizon -- then paying a price now that will produce a good result if that judgment turns out to be sound.
The price paid also must provide a margin of safety for the unforeseen and unforeseeable.
I think it is safe to say that those who primarily focus on making correct judgments about price action, especially those with an average holding period shorter than 3 to 5 years, are probably less influenced by Graham and Dodd and the many investors that have since built upon their theoretical framework.
There are exceptions, of course, but discrepancies between business value and price mostly need to play out over many years. Near-term price action are just votes that, in the near-term, reveal not much about how the price/value discrepancy will be resolved.
The hard work for those heavily influenced by Graham and Dodd is in figuring out what something is worth not trying to figure out what the stock will do. The stock will generally do just fine in the long run if business value was judged well.
Buffett later went on to say...
"Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value."
Well, Mason Hawkins and his team seem also very much focused on the variables of price and value. In one of his answers, Hawkins mentioned that they have...
"...a master list of appraisals for 600+ good businesses that we would like to own at the right price."
That's a rather expansive "master list" yet they still end up with a nicely concentrated portfolio when it's all said and done. In my view, owning shares in fewer businesses for a very long time means that big surprises become less likely over time as familiarity with the business and industry grows. So, as a result, there's less chance of getting the valuation very wrong. So my own preference happens to be owning fewer quality businesses for a very long time.***
While that may work for me it is just one of many ways to go about it.
Searching for discrepancies between price and value is the common theme but the specific approach for each investor is necessarily not one size fits all.
There's a wide range of effective ways to get results. For example, Walter Schloss, one of the 'superinvestors", often had a rather large number of stocks in his portfolio. His style is very much unlike Warren Buffett's and Charlie Munger's strong preference for portfolio concentration. It's not unusual for the Berkshire Hathaway (BRKa) equity portfolio to have 60-70 percent and, at times, even more allocated to just five stocks.
Like anything else, the best approach is consistent with individual limits and capabilities, realistically assessed, instead of wishful thinking or overconfidence.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Some might prefer more or less diversification.
Others may be a bit more or less active.
Maybe a particular knowledge or expertise lends itself to investing in certain types of businesses or industries.
The list goes on.
There are many variations always come back to the common theme of a focus on two variables: price and value.
Adam
* The "superinvestors" mentioned by Warren Buffett include: Walter Scloss, Tom Knapp (Tweedy Browne), Ed Anderson (Tweedy Browne), Bill Ruane (Sequoia Fund) , Rick Guerin, Stan Perlmeter and, of course, Charlie Munger (plus two funds managed by multiple managers).
** That doesn't mean those participants who may be generally more price action conscious don't, at times, use valuation as part of the justification for their trades. Market participants of all kinds draw from a variety of influences.
*** It's an approach that starts and ends with recognition of my own limits. Lower portfolio turnover, higher portfolio concentration, and generating returns primarily from increases to per share intrinsic value of the businesses themselves over time is what has worked best. Beyond the benefits of lower frictional costs, less moves means fewer mistakes. So, as a result, I buy the shares of a limited number of high quality businesses -- those I find understandable that are run by capable owner-oriented executives -- whenever they sell at a plain discount to my estimate of value. From there it is mostly about waiting as long as necessary for the right price then, when the price is right, buying a meaningful amount with the intent to hold long-term.
The Superinvestors of Graham-and-Doddsville
---
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, September 19, 2012
Apple's iOS vs Google's Android: Who's Winning?
According to this article, Google's (GOOG) Android is Winning. At a minimum, the latest worldwide market share numbers for the Android operating system were rather impressive during the 2nd quarter.
But is Android really winning?
But is Android really winning?
According to Gartner, mobile devices using Android captured roughly 64 percent of worldwide market share.
Apple's (AAPL) iOS-based iPhone captured more like a bit under 19 percent.
Now, as this article points out, consider that it was a quarter where Apple's iPhone purchases had "paused" in anticipation of the iPhone 5. Of course, that's not going to close the huge market share gap but is still relevant.
There's also a huge difference in economics.
There's also a huge difference in economics.
This article compares Apple's profit share to competitors and also provides a useful chart.
It turns out that Apple had 77 percent of the mobile industry profits in the 2nd quarter. Who wins from here? I don't know but you have to define what winning is. If market share is your objective, then Android seems to be winning. If profit share is the objective, then it's iOS that's winning.
In my book it's whoever has an approach that ends up sustaining high return long-term profitability.
(As opposed to chasing low return market share, indefinitely. Going after market share for a while can be a smart, but only ultimately makes sense if it ends up generating high returns on capital for shareholders.)
Naturally, the current numbers can't reveal what's going to happen over the long haul, but Apple's profit share is rather exceptional. That doesn't mean Google (and competitors that rely on Android) aren't also doing what's right for themselves.
So the company's fortunes is now firmly driven by that phone more so than other other products. It's not just because it makes up such a large percentage of revenue. It's also because the margins on the iPhone come in something like 2x that of the iPad. According to this article, the iPhone has had gross margins in the 49 to 58 percent range while the iPad is more like 23 to 32 percent going back to 2010 (April 2010 for the iPhone and October 2010 for the iPad).
Healthy margins in both cases, at least for now, though still difficult to gauge just how that might change over time.
(Also, consider that the iPhone was likely held back by the anticipation of a new release.)
Nearly 80 percent of Apple's total revenue during the quarter was from products based upon iOS. Products based on iOS include the iPhone, iPad, and iPod Touch. What's worth noting is just how much of Apple's revenue and profits come from just the iPhone. According to this 8-K, revenue from products based on iOS was $ 30.5 billion for the quarter with $ 22.7 billion coming from iPhone. Based upon the gross margins noted above and the revenue mix, the iPhone likely makes up a bit less than two-thirds of Apple's profits.
Apple's blended gross margin were 42.8 percent and net margin more like 25.2 percent.
All very impressive especially since the company's return on capital is currently just spectacular by any measure (though it'd be nice if they'd do something more productive with all their cash and investments).
What happens to those margins over time is worth watching closely. There's enough moving parts to make it not easy, at least for me, to judge what Apple's likely to be worth several years from now.
I invested in Apple quite a while back and continue to own it. I did that because of its extreme low valuation then and an incredible balance sheet. Well, it still has an incredible balance sheet and, in fact, it has become only stronger. Valuation is a different story. It's certainly not plainly expensive. Not at all. Still, unlike some other investments, it's just not easy to judge what its intrinsic value is likely going to be over a longer time horizon.
I'm not going to be surprised if the stock does just fine. As always, I never have an opinion about near term or even longer term price action of any stock. The company could easily continue to roll like nothing else ever has.
Tough to bet that they will not.
Whether there really is sufficient margin of safety to buy it for the long-term near the current valuation is a whole different question.
Though I admire the company (and Google for that matter), all I know is I won't be buying more shares anytime soon.
It turns out that Apple had 77 percent of the mobile industry profits in the 2nd quarter. Who wins from here? I don't know but you have to define what winning is. If market share is your objective, then Android seems to be winning. If profit share is the objective, then it's iOS that's winning.
In my book it's whoever has an approach that ends up sustaining high return long-term profitability.
(As opposed to chasing low return market share, indefinitely. Going after market share for a while can be a smart, but only ultimately makes sense if it ends up generating high returns on capital for shareholders.)
Naturally, the current numbers can't reveal what's going to happen over the long haul, but Apple's profit share is rather exceptional. That doesn't mean Google (and competitors that rely on Android) aren't also doing what's right for themselves.
So the company's fortunes is now firmly driven by that phone more so than other other products. It's not just because it makes up such a large percentage of revenue. It's also because the margins on the iPhone come in something like 2x that of the iPad. According to this article, the iPhone has had gross margins in the 49 to 58 percent range while the iPad is more like 23 to 32 percent going back to 2010 (April 2010 for the iPhone and October 2010 for the iPad).
Healthy margins in both cases, at least for now, though still difficult to gauge just how that might change over time.
(Also, consider that the iPhone was likely held back by the anticipation of a new release.)
Nearly 80 percent of Apple's total revenue during the quarter was from products based upon iOS. Products based on iOS include the iPhone, iPad, and iPod Touch. What's worth noting is just how much of Apple's revenue and profits come from just the iPhone. According to this 8-K, revenue from products based on iOS was $ 30.5 billion for the quarter with $ 22.7 billion coming from iPhone. Based upon the gross margins noted above and the revenue mix, the iPhone likely makes up a bit less than two-thirds of Apple's profits.
Apple's blended gross margin were 42.8 percent and net margin more like 25.2 percent.
All very impressive especially since the company's return on capital is currently just spectacular by any measure (though it'd be nice if they'd do something more productive with all their cash and investments).
What happens to those margins over time is worth watching closely. There's enough moving parts to make it not easy, at least for me, to judge what Apple's likely to be worth several years from now.
I invested in Apple quite a while back and continue to own it. I did that because of its extreme low valuation then and an incredible balance sheet. Well, it still has an incredible balance sheet and, in fact, it has become only stronger. Valuation is a different story. It's certainly not plainly expensive. Not at all. Still, unlike some other investments, it's just not easy to judge what its intrinsic value is likely going to be over a longer time horizon.
I'm not going to be surprised if the stock does just fine. As always, I never have an opinion about near term or even longer term price action of any stock. The company could easily continue to roll like nothing else ever has.
Tough to bet that they will not.
Whether there really is sufficient margin of safety to buy it for the long-term near the current valuation is a whole different question.
Though I admire the company (and Google for that matter), all I know is I won't be buying more shares anytime soon.
Adam
Long positions in Apple and Google established at much lower than recent prices.
Reuters: Apple margins for iPad about half of iPhone
---
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 positions in Apple and Google established at much lower than recent prices.
Reuters: Apple margins for iPad about half of iPhone
---
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, September 17, 2012
Klarman & Graham: The Margin of Safety Principle
From the introduction section of Seth Klarman's book Margin of Safety:
"If investors could predict the future direction of the market, they would certainly not choose to be value investors all the time.
Indeed, when securities prices are steadily increasing, a value approach is usually a handicap; out-of-favor securities tend to rise less than the public's favorites."
In rising markets, it's the favored stocks that have captured the imagination of active participants that tend to do better than what, at least in the near term, might be out of favor (cheap or otherwise). In the book Seth Klarman points out that those with a value focus tend to sell "too soon" as equities, in general, go from becoming fully valued to just being plain overvalued.
I'd add that, for similar reasons, a value approach also often leads to buying and selling "too soon".*
More from Margin of Safety:
"The most beneficial time to be a value investor is when the market is falling. This is when downside risk matters and when investors who worried only about what could go right suffer the consequences of undue optimism. Value investors invest with a margin of safety that protects them from large losses in declining markets.
Those who can predict the future should participate fully...when the market is about to rise and get out of the market before it declines. Unfortunately, many more investors claim the ability to foresee the market's direction than actually possess that ability. (I myself have not met a single one.) Those of us who know that we cannot accurately forecast security prices are well advised to consider value investing, a safe and successful strategy in all investment environments."
Some might be tempted to adjust investing styles and strategies to the environment.
In other words, in addition to a value focus, why not try to learn how to predict the direction of price action of a particular security or for the market as a whole?
Why suffer the consequences of selling or buying too early, right?
Well, best of luck with that.
Maybe more than a few can actually predict the future direction of the market effectively. Yet consider me skeptical that a methodology, whatever it might be, can be applied by a large number of market participants in a way that reliably produces above average results.
It just doesn't seem very likely this can be done reliably well. My guess is the result would be costly mistakes leading to sub-par returns over the long haul for most who try.
At a minimum, identifying examples of those that can reliably foresee the future direction of the market, and have a proven track record, isn't easy.
(I suspect this won't deter those who seem to try!)
By comparison, finding examples of capable value investors with proven long-term track records is rather easy.
There's plenty of evidence that any number of variations of disciplined value investing can produce attractive long-term results. The primary driver of returns is intrinsic business value and how it changes over time and no real need to know what direction the market might be headed near term. The market is simply there to serve the investor.
Value investing only works over the long haul if securities are purchased with an appropriate margin of safety (even if in the short run price action implies otherwise) and value is consistently well-judged. The benefits of a well-executed value approach is particularly significant when viewed through a risk-adjusted prism.
One serious mistake that gets made is as follows: projecting forward the earnings a business has produced under recent favorable economic conditions. In other words, not enough consideration of what they'll look like under much less than optimal conditions. The end result ends up being an insufficient margin of safety. For all but the highest quality businesses earnings needs to be normalized over at least a full business cycle.
For some lower quality businesses -- particularly those that are capital intensive, highly cyclical, and in fiercely competitive industries -- a full business cycle may not even enough.
Benjamin Graham had the following to say in Chapter 20 of The Intelligent Investor.**
"...the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to 'earning power' and assume that prosperity is synonymous with safety."
Earning power under favorable business conditions is usually insufficient. It is especially the case for the lower quality variety of enterprise. Understanding how earning power might vary over a full business cycle (again, and sometimes even longer) matters a bunch.
As does balance sheet strength. Weaker franchises require the most balance sheet flexibility.
The higher quality enterprises (and I'm generally NOT talking about fast-growers or highly dynamic industries), those that sometimes even seem just a little expensive, will often suffer rather modest drops in earnings during periods of severely unfavorable business conditions.
Judging their normalized earning power, and how it may increase over the long haul, is more straightforward than most.
The benefits of their relative earnings persistence shouldn't be underestimated but frequently is.
The lower quality enterprises, those that may even appear cheap but in reality are anything but, will sometimes see near catastrophic drops in earnings capacity during severely unfavorable business conditions.
Judging their normalized earning power is far from straightforward.
For these, it is more likely that a substantial misjudgment by the investor will end up being made. So, inevitably, they demand a much larger margin of safety and, more often than not, they should just be avoided due to the wide range of possible outcomes.
The most vulnerable businesses, especially those that don't prepare operationally and financially for the next severe drop in economic activity, will leave common equity shareholders wondering what happened to what once appeared to be a nice margin of safety.
Adam
* It seems not exactly surprising those with a value focus (and less interested in playing near-term price action) would be early sellers and buyers. There are many reasons why what's cheap just gets cheaper and vice versa in the near-term and, yes, sometimes for a bit longer. It seems inevitable that those who invest primarily with value in mind will, at times, act too early in either situation. If something is plainly cheap accumulation has to begin at some point and it's likely not at the eventual lowest price. Yet selling and buying early is anything but a big problem long-term if you're mostly getting business value right and clearly paying a nice discount. Only if the investing time horizon is short is it a real issue. So it's learning to not be annoyed by, or pay much attention to, near term price action. Not always easy. It's a necessary trained response considering how much loss aversion can impact investing behavior. I mean, a value focus should lead logically to the hope that what is cheap does get even cheaper in the near or even intermediate term. This is especially true during the share accumulation process but not limited to it. A stock that gets cheaper -- and I've covered this many times -- also allows the benefits per dollar spent on a buyback to be even more potent for long-term owners. The important thing is, of course, that shares are actually selling below intrinsic value. So if value has been judged generally well, then a temporarily lower stock price is a very good thing. Learning to manage the innate influence of loss aversion is probably the toughest part for most. Attempts to buy at the lowest price creates its own problems. One being possibly owning few shares (or no shares) when an investor wants to own a meaningful amount (a partial or complete error of omission). What if the stock happens to unexpectedly reverse course? Some may not consider this but it is a real risk. Maybe the window of opportunity closes, maybe it doesn't. What's worse, staring at temporary paper losses for some time, or permanently missing the chance to own a meaningful amount of something for the long-haul? When highly confident that an attractive long-term investment is selling plainly below what it's worth, it's important to buy it in some quantity when the chance is there. It's difficult enough to find something one understands and wants to own for the long haul. Why worry about some near term price fluctuations in those cases?
** Margin of safety is the principle focus of Chapter 20.
Intro. 12
---
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.
"If investors could predict the future direction of the market, they would certainly not choose to be value investors all the time.
Indeed, when securities prices are steadily increasing, a value approach is usually a handicap; out-of-favor securities tend to rise less than the public's favorites."
In rising markets, it's the favored stocks that have captured the imagination of active participants that tend to do better than what, at least in the near term, might be out of favor (cheap or otherwise). In the book Seth Klarman points out that those with a value focus tend to sell "too soon" as equities, in general, go from becoming fully valued to just being plain overvalued.
I'd add that, for similar reasons, a value approach also often leads to buying and selling "too soon".*
More from Margin of Safety:
"The most beneficial time to be a value investor is when the market is falling. This is when downside risk matters and when investors who worried only about what could go right suffer the consequences of undue optimism. Value investors invest with a margin of safety that protects them from large losses in declining markets.
Those who can predict the future should participate fully...when the market is about to rise and get out of the market before it declines. Unfortunately, many more investors claim the ability to foresee the market's direction than actually possess that ability. (I myself have not met a single one.) Those of us who know that we cannot accurately forecast security prices are well advised to consider value investing, a safe and successful strategy in all investment environments."
Some might be tempted to adjust investing styles and strategies to the environment.
In other words, in addition to a value focus, why not try to learn how to predict the direction of price action of a particular security or for the market as a whole?
Why suffer the consequences of selling or buying too early, right?
Well, best of luck with that.
Maybe more than a few can actually predict the future direction of the market effectively. Yet consider me skeptical that a methodology, whatever it might be, can be applied by a large number of market participants in a way that reliably produces above average results.
It just doesn't seem very likely this can be done reliably well. My guess is the result would be costly mistakes leading to sub-par returns over the long haul for most who try.
At a minimum, identifying examples of those that can reliably foresee the future direction of the market, and have a proven track record, isn't easy.
(I suspect this won't deter those who seem to try!)
By comparison, finding examples of capable value investors with proven long-term track records is rather easy.
There's plenty of evidence that any number of variations of disciplined value investing can produce attractive long-term results. The primary driver of returns is intrinsic business value and how it changes over time and no real need to know what direction the market might be headed near term. The market is simply there to serve the investor.
Value investing only works over the long haul if securities are purchased with an appropriate margin of safety (even if in the short run price action implies otherwise) and value is consistently well-judged. The benefits of a well-executed value approach is particularly significant when viewed through a risk-adjusted prism.
One serious mistake that gets made is as follows: projecting forward the earnings a business has produced under recent favorable economic conditions. In other words, not enough consideration of what they'll look like under much less than optimal conditions. The end result ends up being an insufficient margin of safety. For all but the highest quality businesses earnings needs to be normalized over at least a full business cycle.
For some lower quality businesses -- particularly those that are capital intensive, highly cyclical, and in fiercely competitive industries -- a full business cycle may not even enough.
Benjamin Graham had the following to say in Chapter 20 of The Intelligent Investor.**
"...the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to 'earning power' and assume that prosperity is synonymous with safety."
Earning power under favorable business conditions is usually insufficient. It is especially the case for the lower quality variety of enterprise. Understanding how earning power might vary over a full business cycle (again, and sometimes even longer) matters a bunch.
As does balance sheet strength. Weaker franchises require the most balance sheet flexibility.
The higher quality enterprises (and I'm generally NOT talking about fast-growers or highly dynamic industries), those that sometimes even seem just a little expensive, will often suffer rather modest drops in earnings during periods of severely unfavorable business conditions.
Judging their normalized earning power, and how it may increase over the long haul, is more straightforward than most.
The benefits of their relative earnings persistence shouldn't be underestimated but frequently is.
The lower quality enterprises, those that may even appear cheap but in reality are anything but, will sometimes see near catastrophic drops in earnings capacity during severely unfavorable business conditions.
Judging their normalized earning power is far from straightforward.
For these, it is more likely that a substantial misjudgment by the investor will end up being made. So, inevitably, they demand a much larger margin of safety and, more often than not, they should just be avoided due to the wide range of possible outcomes.
The most vulnerable businesses, especially those that don't prepare operationally and financially for the next severe drop in economic activity, will leave common equity shareholders wondering what happened to what once appeared to be a nice margin of safety.
Adam
* It seems not exactly surprising those with a value focus (and less interested in playing near-term price action) would be early sellers and buyers. There are many reasons why what's cheap just gets cheaper and vice versa in the near-term and, yes, sometimes for a bit longer. It seems inevitable that those who invest primarily with value in mind will, at times, act too early in either situation. If something is plainly cheap accumulation has to begin at some point and it's likely not at the eventual lowest price. Yet selling and buying early is anything but a big problem long-term if you're mostly getting business value right and clearly paying a nice discount. Only if the investing time horizon is short is it a real issue. So it's learning to not be annoyed by, or pay much attention to, near term price action. Not always easy. It's a necessary trained response considering how much loss aversion can impact investing behavior. I mean, a value focus should lead logically to the hope that what is cheap does get even cheaper in the near or even intermediate term. This is especially true during the share accumulation process but not limited to it. A stock that gets cheaper -- and I've covered this many times -- also allows the benefits per dollar spent on a buyback to be even more potent for long-term owners. The important thing is, of course, that shares are actually selling below intrinsic value. So if value has been judged generally well, then a temporarily lower stock price is a very good thing. Learning to manage the innate influence of loss aversion is probably the toughest part for most. Attempts to buy at the lowest price creates its own problems. One being possibly owning few shares (or no shares) when an investor wants to own a meaningful amount (a partial or complete error of omission). What if the stock happens to unexpectedly reverse course? Some may not consider this but it is a real risk. Maybe the window of opportunity closes, maybe it doesn't. What's worse, staring at temporary paper losses for some time, or permanently missing the chance to own a meaningful amount of something for the long-haul? When highly confident that an attractive long-term investment is selling plainly below what it's worth, it's important to buy it in some quantity when the chance is there. It's difficult enough to find something one understands and wants to own for the long haul. Why worry about some near term price fluctuations in those cases?
** Margin of safety is the principle focus of Chapter 20.
Intro. 12
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, September 14, 2012
Grantham & Buffett: "Career Risk" & "The Institutional Imperative"
Jeremy Grantham had this to say about what he calls "career risk" in his April 2012 letter:
"The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples' money. The prime directive, as [John Maynard] Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority 'go with the flow,' either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest."
He also talked about "career risk" in part 2 of his January 2011 letter:
"Career risk drives the institutional world. Basically,everyone behaves as if their job description is 'keep it.' Keynes explains perfectly how to keep your job: never, ever be wrong on your own. You can be wrong in company; that's okay."
Investment professionals certainly had to wrestle with "career risk" head on during the dot-com bubble. At the time, more than a little conviction and willingness to appear very wrong for quite a long time was necessary. Some pros rightly resisted the herd and were promptly rewarded with client redemptions.
Unceremoniously dumped as investors chased the "new paradigm".
Supposedly, those that weren't buying the hottest tech stocks just didn't "get it" or at least that's what much of the herd seemed to be thinking. Well, there was no new valuation paradigm. Many transformative companies were created (and plenty less so) but, either way, valuations went to ludicrous extremes. Only after the fact (and, unfortunately for some money managers, after the money had left) is it usually clear who really "gets it".*
This likely helps to explain something Warren Buffett pointed out in the 1978 Berkshire Hathaway (BRKa) shareholder letter:
"...in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks."
Jeremy Grantham happens to be describing a specific investment industry dynamic but, even if not precisely the same, it is not unlike something more generalized that Warren Buffett has covered from time to time.
What he calls "the institutional imperative".**
From the 1989 Berkshire shareholder letter:
"My most surprising discovery: the overwhelming importance in business of an unseen force that we might call "the institutional imperative."
Basically, in Buffett's view, the imperative is a powerful tendency to imitate peer companies, at times rather foolishly, on things like acquisitions, executive compensation, expansion plans or whatever else.**
He described it in the 1990 Berkshire shareholder letter this way:
"...the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so."
Buffett makes it clear he considers the power of "the institutional imperative" to be rather substantial. In fact, so much so that Berkshire Hathaway has been deliberately set up to minimize its influence. Also, he prefers to invest in companies that seem to have an awareness of the problem.
Adam
Long position in BRKb established at lower prices
Related posts:
Buffett on "The Institutional Imperative"
Buffett: A Portrait of Business Discipline
* And it's not like having money drain out of a fund (or funds) doesn't create its own return sapping headaches for a professional money manager. Part of the brilliance of Berkshire Hathaway is how it is designed to prevent this problem and, in fact, benefit from it.
** Check out the Mistakes of the First Twenty-five Years section of the 1989 Berkshire shareholder letter (the section is near the end of that letter) for more background on this.
---
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 central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples' money. The prime directive, as [John Maynard] Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority 'go with the flow,' either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest."
He also talked about "career risk" in part 2 of his January 2011 letter:
"Career risk drives the institutional world. Basically,everyone behaves as if their job description is 'keep it.' Keynes explains perfectly how to keep your job: never, ever be wrong on your own. You can be wrong in company; that's okay."
Investment professionals certainly had to wrestle with "career risk" head on during the dot-com bubble. At the time, more than a little conviction and willingness to appear very wrong for quite a long time was necessary. Some pros rightly resisted the herd and were promptly rewarded with client redemptions.
Unceremoniously dumped as investors chased the "new paradigm".
Supposedly, those that weren't buying the hottest tech stocks just didn't "get it" or at least that's what much of the herd seemed to be thinking. Well, there was no new valuation paradigm. Many transformative companies were created (and plenty less so) but, either way, valuations went to ludicrous extremes. Only after the fact (and, unfortunately for some money managers, after the money had left) is it usually clear who really "gets it".*
This likely helps to explain something Warren Buffett pointed out in the 1978 Berkshire Hathaway (BRKa) shareholder letter:
"...in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks."
Jeremy Grantham happens to be describing a specific investment industry dynamic but, even if not precisely the same, it is not unlike something more generalized that Warren Buffett has covered from time to time.
What he calls "the institutional imperative".**
From the 1989 Berkshire shareholder letter:
"My most surprising discovery: the overwhelming importance in business of an unseen force that we might call "the institutional imperative."
Basically, in Buffett's view, the imperative is a powerful tendency to imitate peer companies, at times rather foolishly, on things like acquisitions, executive compensation, expansion plans or whatever else.**
He described it in the 1990 Berkshire shareholder letter this way:
"...the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so."
Buffett makes it clear he considers the power of "the institutional imperative" to be rather substantial. In fact, so much so that Berkshire Hathaway has been deliberately set up to minimize its influence. Also, he prefers to invest in companies that seem to have an awareness of the problem.
Adam
Long position in BRKb established at lower prices
Related posts:
Buffett on "The Institutional Imperative"
Buffett: A Portrait of Business Discipline
* And it's not like having money drain out of a fund (or funds) doesn't create its own return sapping headaches for a professional money manager. Part of the brilliance of Berkshire Hathaway is how it is designed to prevent this problem and, in fact, benefit from it.
** Check out the Mistakes of the First Twenty-five Years section of the 1989 Berkshire shareholder letter (the section is near the end of that letter) for more background on this.
---
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, September 12, 2012
Why Buffett Prefers Using Cash Over Stock in Acquisitions
Both stock and cash was used for the merger of Burlington Northern Santa Fe (BNSF) into a subsidiary of Berkshire Hathaway (BRKa) back in early 2010. Yet, whenever possible, Warren Buffett has made it very clear he prefers using cash instead of stock in mergers/acquisitions.
In the 1997 letter, Buffett said the following about prior deals involving Berkshire's stock up to that point:
"If you aggregate all of our stock-only mergers (excluding those we did with two affiliated companies, Diversified Retailing and Blue Chip Stamps), you will find that our shareholders are slightly worse off than they would have been had I not done the transactions. Though it hurts me to say it, when I've issued stock, I've cost you money."
The problem wasn't that the businesses they did deals for ended up being poor performers or that they were somehow misled by the sellers.
Not at all.
"Instead, our problem has been that we own a truly marvelous collection of businesses, which means that trading away a portion of them for something new almost never makes sense. When we issue shares in a merger, we reduce your ownership in all of our businesses -- partly-owned companies such as Coca-Cola, Gillette and American Express, and all of our terrific operating companies as well. An example from sports will illustrate the difficulty we face: For a baseball team, acquiring a player who can be expected to bat .350 is almost always a wonderful event -- except when the team must trade a .380 hitter to make the deal.
Because our roster is filled with .380 hitters, we have tried to pay cash for acquisitions, and here our record has been far better."
Buffett later added...
"These acquisitions have delivered Berkshire tremendous value -- indeed, far more than I anticipated when we made our purchases."
In 1998, not long after the 1997 letter was written, Berkshire would go on to use its stock to merge with General Re for roughly $ 22 billion. It was a deal that added meaningfully to Berkshire's share count (it was a more than 20 percent increase in shares outstanding).
The far more recent BNSF deal was structured to be roughly 60 percent cash and 40 percent stock. Buffett explained it this way in the 2010 Berkshire letter:
"It now appears that owning this railroad will increase Berkshire's 'normal' earning power by nearly 40% pre-tax and by well over 30% after-tax. Making this purchase increased our share count by 6% and used $22 billion of cash. Since we've quickly replenished the cash, the economics of this transaction have turned out very well."
In a perfect world he'd have not used stock but this BNSF deal had a much smaller impact on shares outstanding. Buffett said this to CNBC just after the deal was announced:
"I don't like to use stock, but on this one, because of the size and because they wanted a tax-free option for shareholders..."
The deal was structured (along with the 50-1 split of the 'B' shares) to enable even those with a small number a shares of BNSF to exchange their shares tax-free for Berkshire stock.
At least compared to prior occasions, it's pretty clear that the BNSF deal was a reasonably good use of the stock. It was certainly a great use of their cash. Using some Berkshire stock to make this happen was also consistent with Buffett's preference to always have lots of cash around. Making sure Berkshire's liquidity remained ample has always been a priority for them (and, I might add, should be for any well run enterprise). After the deal was done there was more than $ 20 billion of cash on the balance sheet. From the CNBC interview:
"...after doing it we will be left with over 20 billion of consolidated cash. So, we like to have a lot of cash around and we'll have a lot of cash around straight through this."
Still, I don't doubt they'd still have rather not used stock in the deal. Yet the opportunity arose to buy a very good large business and they did the deal that made sense consistent with their principles but within real world constraints. If they waited until they could do the deal with all cash who knows if the opportunity would have been there to buy the business at an attractive valuation.
So Buffett doesn't like to use Berkshire's stock but, under the right circumstances, it happens. There was 1.23 million Class A equivalent common shares outstanding at the end of 1997. These days, there's more like 1.65 million.
That increase in share count over 15 years or so comes mostly down to the General Re and BNSF deals.
Adam
Long BRKb
Berkshire Hathaway To Acquire Burlington Northern Santa Fe - Nov. 2009
Berkshire and BNSF Close Merger - Feb. 2010
---
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 the 1997 letter, Buffett said the following about prior deals involving Berkshire's stock up to that point:
"If you aggregate all of our stock-only mergers (excluding those we did with two affiliated companies, Diversified Retailing and Blue Chip Stamps), you will find that our shareholders are slightly worse off than they would have been had I not done the transactions. Though it hurts me to say it, when I've issued stock, I've cost you money."
The problem wasn't that the businesses they did deals for ended up being poor performers or that they were somehow misled by the sellers.
Not at all.
"Instead, our problem has been that we own a truly marvelous collection of businesses, which means that trading away a portion of them for something new almost never makes sense. When we issue shares in a merger, we reduce your ownership in all of our businesses -- partly-owned companies such as Coca-Cola, Gillette and American Express, and all of our terrific operating companies as well. An example from sports will illustrate the difficulty we face: For a baseball team, acquiring a player who can be expected to bat .350 is almost always a wonderful event -- except when the team must trade a .380 hitter to make the deal.
Because our roster is filled with .380 hitters, we have tried to pay cash for acquisitions, and here our record has been far better."
Buffett later added...
"These acquisitions have delivered Berkshire tremendous value -- indeed, far more than I anticipated when we made our purchases."
In 1998, not long after the 1997 letter was written, Berkshire would go on to use its stock to merge with General Re for roughly $ 22 billion. It was a deal that added meaningfully to Berkshire's share count (it was a more than 20 percent increase in shares outstanding).
The far more recent BNSF deal was structured to be roughly 60 percent cash and 40 percent stock. Buffett explained it this way in the 2010 Berkshire letter:
In a perfect world he'd have not used stock but this BNSF deal had a much smaller impact on shares outstanding. Buffett said this to CNBC just after the deal was announced:
"I don't like to use stock, but on this one, because of the size and because they wanted a tax-free option for shareholders..."
The deal was structured (along with the 50-1 split of the 'B' shares) to enable even those with a small number a shares of BNSF to exchange their shares tax-free for Berkshire stock.
At least compared to prior occasions, it's pretty clear that the BNSF deal was a reasonably good use of the stock. It was certainly a great use of their cash. Using some Berkshire stock to make this happen was also consistent with Buffett's preference to always have lots of cash around. Making sure Berkshire's liquidity remained ample has always been a priority for them (and, I might add, should be for any well run enterprise). After the deal was done there was more than $ 20 billion of cash on the balance sheet. From the CNBC interview:
"...after doing it we will be left with over 20 billion of consolidated cash. So, we like to have a lot of cash around and we'll have a lot of cash around straight through this."
Still, I don't doubt they'd still have rather not used stock in the deal. Yet the opportunity arose to buy a very good large business and they did the deal that made sense consistent with their principles but within real world constraints. If they waited until they could do the deal with all cash who knows if the opportunity would have been there to buy the business at an attractive valuation.
So Buffett doesn't like to use Berkshire's stock but, under the right circumstances, it happens. There was 1.23 million Class A equivalent common shares outstanding at the end of 1997. These days, there's more like 1.65 million.
That increase in share count over 15 years or so comes mostly down to the General Re and BNSF deals.
Adam
Long BRKb
Berkshire Hathaway To Acquire Burlington Northern Santa Fe - Nov. 2009
Berkshire and BNSF Close Merger - Feb. 2010
---
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.
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