Buffett on Microsoft

In this recent Reuters interview, Warren Buffett gave the following answer when asked about Microsoft (MSFT):

I regard myself as precluded from either personally or having Berkshire buy Microsoft because if something good happened the following week people would think Bill had told me. So I just see no way that we can ever buy Microsoft and be sure that we won't look like we had some kind of inside information or something. So it's off limits. It did look pretty cheap.

A somewhat surprising answer after years of just saying he avoids tech for the most part due to the nature of tech businesses themselves. Tech business that have an economic moat eventually have that moat threatened by some technology shift or new competition.

Suddenly, what seemed like a fantastic business is not. Buffett clearly has historically liked durable businesses residing in industry with little change going on. Obviously, that's rarely going to be found in technology.

The above seems practically like an endorsement of Microsoft's stock coming from him.

Adam

Long position in MSFT

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Buffett on Macro Forecasts: Berkshire Shareholder Letter Highlights

Warren Buffett wrote the following in the 1994 Berkshire Hathaway (BRKa) shareholder letter:

We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise - none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.

These comments by Buffett are worth considering the next time one of the many who are in the business of making macro forecasts opines on business news.

At the very least, remember it the next time someone confidently predicts what the macroeconomic future will be and then makes a specific investing strategy recommendation based upon it.

Adam

Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Jamie Dimon Challenges Bernanke

Jamie Dimon, the Chief Executive Officer of J.PMorgan Chase (JPM), had some things to say (in a public forum no less) about bank regulations to Ben Bernanke earlier this week. He's of the view regulators have gone too far and are slowing economic growth.

Bloomberg: Dimon Challenges Bernanke

I'm sure some will see this just as a banker whining about the rules. I'm certainly someone who wants systemic risk reduced and the banks speculative activities reigned in.

I also happen to think it mostly needs to be done by separating or limiting short-term speculative trading activities financed with guaranteed money (other peoples money) and through the modification of bank executive compensation systems (bankers with more skin in the game...more negative consequences if they take dumb risks).

Ultimately, I'd prefer changes that encourage banks to focus on financing vital industries instead of financing prop trading desks focused on the short-term.

It seems that some of the well-intentioned regulatory changes have lost focus. Dimon thinks overzealous regulation is hurting the economic rebound. He wonders whether in 20 years we'll look back on this time amd realize all the things we did to slow down the recovery.

What might be considered good examples of the lack of focus?

Considering the size of Dodd-Frank Act (well over 2000 pages in length), it's more than a little disappointing that so little has been done so far about the things that really got us into trouble. I mean, whether you think debit card swipe fee reform (part of Dodd-Frank) is fair or not it made no contribution to the crisis.

There is tons of complexity and uncertainty about what the new rules of the game will be. The rules have to be locked down if we want a more healthy expansion of credit to occur.

Much of what has been done appears to be potentially throttling the socially useful things that banks do.

A bank that provides credit to a sound business can help facilitate productive economic activity and growth.

A bank that funds a prop trading desk -- and things like it -- is of little to no value or worse.

The uncertainties created in this environment are holding both back.  We need to lock down changes that will drive more of the former and less of the latter.

Adam

Long JPM

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Buffett on Coca-Cola: Berkshire Shareholder Letter Highlights

The excerpt below provides some historical perspective on Coca-Coca (KO).

As a major holding of Berkshire Hathaway (BRKa), Warren Buffett not surprisingly draws from the example of Coca-Cola but, from my perspective, what he says below applies to many other high qualiity franchises.

Which ones? Things like Pepsi: PEP, Heinz: HNZ, Diageo: DEO and Johnson & Johnson: JNJ come to mind among many others (i.e. brands consumed everyday with scale and broad distribution).

From the 1993 Berkshire Hathaway shareholder letter:

Let me add a lesson from history: Coke went public in 1919 at $40 per share. By the end of 1920 the market, coldly reevaluating Coke's future prospects, had battered the stock down by more than 50%, to $19.50. At yearend 1993, that single share, with dividends reinvested, was worth more than $2.1 million. As Ben Graham said: "In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine."

Later in the letter, Buffett highlights a Fortune article from 1938. The writer of the article implies that it was already too late, back in 1938, to benefit from the ownership of Coca-Cola's stock:

In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: "Several times every year a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him."

Yes, competition there was in 1938 and in 1993 as well. But it's worth noting that in 1938 The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.

Coca-Cola's potential to compound in value wasn't done in 1938 or 1993 and certainly isn't now. Though a large company, the economics that have propelled Coca-Cola's value upward aren't anywhere near exhausted.

Still, I'm guessing some will judge Coca-Cola's future propects beyond 2011 in a similar manner to that Fortune writer. That, once again, Coca-Cola is a great company with upside limited by sheer size and competition. Basically, that investors too late...again.

With the above in mind, consider how often layers of complexity and cost are added to the investing process when a perfectly sound and straightforward option is right there in front of you.

Below is an example (one of many) of how investing can be made more difficult and expensive than it otherwise needs to be. According to this Wall Street Journal article by Jason Zweig, an e-mail from Action Alerts PLUS, a trading tip service of Jim Cramer, claimed "My portfolio is CRUSHING the S&P 500..." and claims to have more than doubled the return of the S&P 500.

A bar graph showed the following performance comparison from January 1, 2002 to April 1:

S&P 500: 15.5% return
Mr. Cramer's Portfolio: 39.2% return

The above results apparently include dividends for Mr. Cramer's portfolio but does not include dividends for the S&P 500. The Wall Street Journal article says that the return of the S&P 500 with dividends was 38.3%.

So just a bit less than Mr.Cramer's portfolio.

Those returns are before trading costs, taxes, and the subscription fee ($ 299.95 for the first year) for the letter. The article points out that something like an average of 774 trades annually would be required.

774 trades? Yikes.

Let's do some math.

774 trades multiplied by a typical $ 7 per trade commission would cost an investor $ 5,418 per year.

So someone with a $ 100,000 portfolio would with $ 5,418 in commissions obviously be incurring more than 5% in frictional costs each year. Obviously, you'd need a much larger portfolio or lower trading costs so those costs don't substantially reduce total returns.

In fact, going back to 2002, a portfolio with 5% in annual commission costs easily wipes out (and then some) the 39.2% claimed total return. So the target audience for this service would have to be someone with much more money than $ 100k. Even so the math just doesn't work since that portfolio didn't even really outperform in the first place.

From the Wall Street Journal article:

...you could have bought and held an S&P 500 index fund and then done utterly nothing except reinvest your dividends. And you, too, would have more than doubled the market's return—calculated without dividends.

Alternatively, you could just steadily buy something like Coca-Cola (and a few of the other great franchises), whenever market prices seem reasonable*, and go beach.

If nothing else you'll save a whole lot on commissions.

Adam

Long all stocks mentioned except Heinz

* Coca-Cola and many other great consumer franchises became extremely expensive in the late 1990s. At that time they could not be bought at prices that would produce a satisfactory return. Market prices for these stocks were materially higher than intrinsic value. The past decade has mostly corrected this in my view.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Lowe's Shareholder-Friendly Buyback Plan

Shares in Home Depot (HD) and Lowe's (LOW) are, respectively, selling at 15x and 14x current year earnings.

That's not exactly expensive but other retailers, the likes of Wal-Mart (WMT) and Target (TGT), are even cheaper selling at more like 11.5-12x this year's expected earnings and some even lower.

Costco (COST), an excellent business, in contrast sells at an earnings multiple north of 20x (though if you take the rather conservative balance sheet into account, the $ 3 billion of net cash, it looks a bit less expensive).

On a forward earnings basis, Home Depot and Lowe's look a bit more reasonably priced.

While forward estimates vary, and are naturally less reliable, 12-13x earnings next year doesn't seem a stretch. What makes their valuations somewhat more compelling is the continued weakness in housing.  If they remain as profitable as they are in this environment, I'm guessing they will be doing just fine several years down the road when the housing market begins to improve.

I happen to like Lowe's slightly more than Home Depot but both are fine businesses in my view.
(Lowe's has been in Stocks to Watch and the Six Stock Portfolio since their inception.)

Lowe's, which has struggled somewhat more than Home Depot, appears to be acting in a very shareholder-friendly manner. Home Depot also seems to be doing some very smart things including improved execution in recent years.

This article in MarketWatch highlights Lowe's plan to reduce shares outstanding via its buyback plan. Over five years Lowe's expects to repurchase $ 18 billion of its common stock. As a result, at least near current prices, its share count would be more than cut in half.

Lowe's is expected to earn $ 2.0 billion this year and $ 2.5 billion next year. If share count is reduced by half from the current 1.33 billion shares over the next five years, Lowe's earning per share would grow to $ 3.75/share even if net earnings does not grow beyond next years expected level.

At a 12.5x multiple of those $ 3.75/share in earnings (it currently sell for a ~14x multiple) in 2016, Lowe's would sell at ~$ 47/share. The stock currently sells at $ 23/share. That's more than a 14% annualized gain (total return would be even higher when you include 2.4% dividend).

The problem is I don't consider that buyback realistic.*

In the real world, odds are the stock will go up before they can accomplish the buyback near current prices. So it would be surprising if they end up being able to complete all $ 18 billion in five years at attractive prices. That means share count will likely drop less even if still by a material amount.

Let's look at an only somewhat more reasonable scenario. If they were able to buyback $ 15 billion of shares for an average price of $ 25/share (shares currently selling at ~ $23/share), the company's shares outstanding would still drop from 1.33 billion to .733 billion over five years. This buyback could also be accomplished with a more manageable amount of incremental debt and interest expense.

At that share count, Lowe's earnings per share would grow to $ 3.40/share using, again, next year's expected level of earnings (including interest expense from incremental debt). I will say that it's likely Lowe's will be earning much more than that five years from now.

At that reduced share count, assuming a 12.5x earnings multiple of those earnings, Lowe's would still sell at $ 42.50/share in 5 years. With the stock currently selling at $ 23/share, that's still slightly more than a 12.6% annualized gain (if you include the 2.4% dividends more like a 15% annualized total return).

In both cases, those returns come about using modest growth assumptions and a relatively low multiple of earnings.

It's worth asking the question: what if the multiple shrinks? Well, the answer is different for someone who's investing strictly over short time horizons versus an investor with some patience. For the patient long-term investor, if the multiple shrinks the company gets to buy back more the stock at lower prices ultimately resulting in even better returns. So, if the stock were to rally meaningfully above that $ 25/share average repurchase price, overall returns will end up being lower over the long haul. Shareholders who don't plan to sell for many years shouldn't be so pleased when the shares of a good business (with the capacity to buyback at a discount) rally in the near-term.

The near-term, and even intermediate-term, rally purely benefits the trader and hurts the long-term owner. On the other hand, if it gets closer to the time that the shares are going to be sold -- and after many years of well-executed buyback -- the stock were to end up selling at a high multiple of earnings, that'd be a very good thing.

This obviously doesn't quite fit with some of the more hyperactive trading strategies. In that more speculative world, I'm guessing 1-2 months would be a considered a long time. Yet, I think, a little time with a simple spreadsheet reveals the folly of trying to figure out how something will perform in three years or less when the average annual return becomes so compelling if the investor increases their investing horizon by at least a few more years.**

This fact seems lost of those involved with investing over shorter time horizons. The only way this ends up not working out is if something materially negative happens to economic moat of the business or management starts misallocating capital.

That's why I happen to think, besides buying with an appropriate margin of safety, investing successfully is mostly about understanding and monitoring the sustainability of competitive advantage and management capital allocation skills.

What are the threats to the advantages that drive the core economics of a business?

Is the management doing smart things with capital?

As I mentioned, Lowe's and Home Depot have been able to earn a healthy amount in what is a terrible environment for housing. An environment that is likely to persist for quite a while yet certainly not forever.

Some time down the road a housing recovery of some sort will kick in and earnings will likely be substantially higher. If that does happen, the price to earnings multiple will also likely expand.

Consider that as upside.

A very attractive scenario for long-term investors in Lowe's would be:

1) The stock stays low, for several years, allowing a large number of shares to be bought back using the least amount of capital possible, followed by 2) a normal housing boom (i.e. not a bubble) kicking into gear.

That will make the stock so-called "dead money" and some will no doubt try to time it. My premise is that if you try to time it you end up with the risk of owning "an eyedropper" (or none) of something when you wanted to own a substantial amount. I'm not saying Lowe's as an investment is all that unique. It's just a good example. There are no doubt better investment opportunities. In fact, quite a few very good low multiple businesses currently have very similar shareholder enriching buyback opportunities.

It's just that when investors decide they like a business, and the price it is available at is fair, it makes no sense to try and time it because of fear that it will be so-called "dead money". I realize this doesn't fit the ethos of the fast money world we live in.

Some final thoughts on Lowe's.

One real possibility is that Lowe's stock goes down further in the short-term. From a buyback (and, of course, long-term returns) perspective that would be a good thing. Stock traders may hate this but investors should welcome it.***

Lowe's near or intermediate term stock performance could easily continue to be unimpressive. Yet, as long as the business continues to have solid core economics, the longer that underperformance in the stock persists the better returns will likely be for shareholders with a long-term investment time horizon.

So with any investment, monitor those things that may adversely impact the long-term economics. Focus on the source of durable competitive advantage and what may be a threat to it.

Otherwise, the arithmetic of what returns will be ends up being five year plus down the road is pretty simple.

Adam

I have long positions in LOW and WMT

* It's clear they would have to take on some $ 6 to $ 8 billion in additional debt to accomplish this within 5 years at current expected earnings and free cash flow levels. I think their balance sheet gives them the room to do so but it does add risk. In this example, we are basically assuming that operating earnings could grow enough to pay the incremental after-tax interest expense. Not a foregone conclusion but, at the same time, seemingly not a stretch either. It's important -- assuming they remain financially and competitively strong -- that they only buyback shares when selling at a plain discount to per share intrinsic value. So meeting that $ 18 billion expectation should take a back seat if the stock gets rather expensive. Also, whether a buyback makes sense will naturally depend upon whether the cash could be bettered used building/strengthening the business (or maybe to make a smart acquisition). Maintaining and strengthening the moat is paramount. That should always take priority over a buyback and, well, pretty much everything else. In all cases, the decision should come down to what will produce the highest returns on capital, with all risks carefully considered, over the long haul. Pursuit of growth that's high risk/low return should be avoided. This seems like it should be obvious but, even with good intentions, growth initiatives too often end up producing lower returns at greater risk compared to simply buying back a cheap stock.

** Average annual return is all that matters even if much of the return ends up back-end loaded. Some will try to time it. Best of luck. That's a recipe to miss perfectly sound long-term investments. You don't get great prices unless something is going to be dead money or, in fact, declining for a quite a while. If you are an institutional investor, pressure will probably prevent you from being allowed to invest in this manner. Individuals with a long-term investing horizon only impose that pressure on themselves.
*** What's an exception to this? Here's a scenario to consider: unfortunately, there's the very real risk that, while the stock is down, a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

The World After QE2

Things were not pretty for the stock market after the end of QE1.

Some are bracing for the same kind of thing with the end of QE2 fast approaching.

I'm not in the business of guessing what the market will do. If the market goes down substantially I buy good businesses at a discount. If it goes to the other extreme, may sell some things that get expensive. That's the extent of my interest in predicting what the market will do.

Having said that, the following article argues that there are some reasons to think that the end of QE2 may not necessarily be a repeat of what happened after QE1.

From Michael Santoli's article in the latest Barron's Magazine:

What's in store post-QE2?

"Hopefully, not much," says Michael Darda...He and others see important differences in the macro backdrop...

At least compared to March of 2010. Some of those important differences...

Credit Spreads Remain Narrow
Darda takes crucial cues from the credit and interbank money markets, both of which are rather unperturbed...

Commercial-Loan Production, Money-Supply Now Growing
A year ago, the banking system was still suffering declines in commercial-loan production, whereas business lending now has turned higher.

The article points out that we now have far more positive money-supply growth. So it would seem the end of QE2 isn't likely to end up being the real problem. It, at least, appears that there is more of a cushion to absorb shocks than there was a year ago, but Santoli points out it makes sense to keep what Mike Tyson once said in mind:

"Everyone has a plan, until they get hit." But the blows, should they come, probably will be from some financial accident in Europe or elsewhere, a downshift in global growth or another shot to corporate confidence—not the end of QE2.

Santoli also points out that the stock market may be higher than a year ago but, in fact, corporate-profit growth has outpaced shares price increases. So stocks in general are not expensive.

I partially agree.

The article highlights companies with clear pricing power in a deflationary arguing that they should do well.

Specifically, it mentions stocks like Philip Morris International (PM), Union Pacific (UNP), Kansas City Southern (KSU), and Schlumberger (SLB). I certainly like Philip Morris International (it has been in the 6 Stock Portfolio and Stocks to Watch since inception) and to a lesser extent Union Pacific, but both of the stocks have gone from being bargains to, if not expensive, certainly not cheap.

Consider that Philip Morris International had a single digit price to earnings multiple when it was first mentioned on this blog as being a good investment at prices available back in April of 2009.

After the rally, from a share price that was back then in the high 30's to where it trades now in the high 60's, that multiple is now in the mid-teens.

It is still a great business, and if held for a very long time returns will be just fine, but these days there are shares in other companies selling at bigger discounts to intrinsic value in my view.

If it ever gets cheap again (and you don't mind owning a tobacco company) those shares are well worth owning as a long-term core holding.

Adam

Long PM and UNP

Buffett on Mergers: Berkshire Shareholder Letter Highlights

From Warren Buffett's 1992 Berkshire Hathaway (BRKa) shareholder letter:

We had a significant investment in a bank whose management was hell-bent on expansion. (Aren't they all?) When our bank wooed a smaller bank, its owner demanded a stock swap on a basis that valued the acquiree's net worth and earning power at over twice that of the acquirer's. Our management - visibly in heat - quickly capitulated. The owner of the acquiree then insisted on one other condition: "You must promise me," he said in effect, "that once our merger is done and I have become a major shareholder, you'll never again make a deal this dumb."

Sometimes (in fact, too often) an acquisition does more to expand management's domain than increase shareholder value.

Management, in order to gain approval, will sometimes make the case for a more-than-fully-priced acquisition using words like strategic or synergistic. Even if the deal works out okay operationally (not exactly a foregone conclusion by the way) the odds are good that existing shareholders will end up poorer when an obviously expensive price is being justified on the basis of the deal being strategic or synergistic.

There are exceptions, of course, but strategic and synergistic is often just code for "this makes my empire bigger at shareholder expense". The fact that shareholders end up a bit poorer, a mere inconvenience.

Keep in mind that, throughout the acquisition process, you can expect management to remain adamant that the deal truly is about enhancing shareholder returns. Yet, when it's all said and done, if you overpay, the transaction is just a complicated way to transfer some of your wealth to the acquiree's shareholders.

Here is a related previous post. In it, Buffett describes some of the ways that management rationalizes issuing stock to purchase another company.

Previous post: Buffett on Favorite Rationalizations

A good business, run by management that sincerely does deals/makes capital allocation decisions with shareholder wealth creation in mind, can be owned for a very long time.

Adam

Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Van Den Berg: Large Cap Technology Stocks Are Cheap

An excerpt from this GuruFocus interview with Arnold Van Den Berg, founder and Co-Chief Investment Officer of Century Management:

"I believe large cap tech stocks are one of the cheapest areas of the market. Stocks like Microsoft (MSFT), Dell (DELL), Cisco (CSCO), and Applied Materials (AMAT) are names that come to mind."

Van Den Berg is yet another value-oriented investor who's lately become interested in large cap tech stocks.

"Isn't it interesting that 10 years ago the market was silly with excitement about tech stocks and willing to pay 30, 40 and 100 times earnings, yet today they sell at 8 to 10x earnings and free cash and the market yawns?"

Now, if Warren Buffett were buying tech stocks we'd really know the investing world had been turned upside down. Check out the full interview.

Adam

Long positions in MSFT, DELL, and CSCO

Related post:
Technology Stocks

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Building a Stronger Financial System

The other day, I posted that Mark Mobius thinks we will have another financial crisis:

"There is definitely going to be another financial crisis around the corner because we haven't solved any of the things that caused the previous crisis..." - Mark Mobius

From what seems to me an unexpected source, Carl Icahn similarly had this to say recently on CNBC:

"I know a lot of my friends on Wall Street will hate my saying this, but the Glass-Steagall thing or something like it wasn't a bad thing...a bank should be a bank. Investment bankers should be investment bankers. Investment bankers serve a purpose...but I think today, and I know a lot of people won't like hearing this...I think we're going back in the same trap, and I will tell you that very few people understood how toxic and how risky those derivatives were."

A little over a year ago, Bogle offered this opinion about the financial system in a CNBC interview:

"I would be cheering for the return of the Glass-Steagall Act," Bogle said, referring to the Depression-era law that banned banks from owning brokerage firms and other financial firms, among other restrictions. "It's pretty much common sense that if you're in the business of taking deposits, you shouldn't be speculating on your balance sheet."

We know Paul Volcker shares similar concerns. It has been difficult to even get a compromised version of his fairly mild (though certainly a step in the right direction in my view) Volcker rule put into place. The implementation of that rule is apparently still months away due, in part, to intense lobbying against the rule.

Reuters: Goldman Lobbying Hard to Weaken Volcker Rule

"They're totally freaked out about Volcker," said a Goldman lobbyist who declined to speak on the record for fear of losing the contract. "People are working on that a lot, with agency staff, with lawmakers, you name it."

Then later in the article...

Goldman has hired an all-star team of lobbyists and former government officials, leveraging powerful connections to get its message across to regulatory and political leaders.

Reuters: Volcker Says Identifying Speculative Trading is Easy

Volcker said he was concerned that the lobbying efforts might water down his eponymous law. He also said banks that find it hard to comply with proprietary trading restrictions probably should not be granted the protections and funding advantages of being part of the Federal Reserve system.

"Obviously, there's a lot of lobbying going on," said Volcker. "But if you want to be a bank, follow the bank rules. If Goldman Sachs and the others want to do proprietary trading, then they shouldn't be banks."

Charlie Munger, not surprisingly, expressed even stronger views against the current system.

In a Forbes interview last year, when many were balking that the Volcker rule was too harsh, Munger said he'd "make Paul Volcker look like a sissy" when it comes to reform:

"I would separate derivatives from the basic bridges of civilization. We don't want civilization contaminated by extreme speculation. I'd ban all the derivatives trading except for metals and commodities. The new stuff is a marvelous gambling game. It swamps any commercial transactions that are needed. Gambling does not become wonderful just because it pertains to commerce. It's a casino." -Charlie Munger

What I see here is a collection of, give or take, similar views that are largely being ignored (just a few hundred years of collective business and finance experience here). Their goals seem mostly oriented toward the promotion of greater system integrity. I just think it is worth noting that none of them seem to have much to gain personally if aspects of the restraints they are recommending become implemented. The conflicts of interest, it would seem, are minimal.

In contrast, the investment banks clearly have plenty to gain directly from blocking reform.

Yet, besides the Volcker rule which is still in flux, their concerns seem largely ignored with only token changes likely to be implemented. None of the proposed/pending reforms come even close to addressing the fundamental flaws in the system that got us into trouble last time.

James Grant wrote in Money of the Mind: "Progress is cumulative in science and engineering, but cyclical in finance." 

John Kenneth Galbraith* also wrote the following in A Short History of Financial Euphoria: "The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."

It would seem to be more than a little unwise to not seriously consider at least some of the above views and sentiments.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Is Apple a Value Stock?

Like any stock, Apple (AAPL) has its own unique set of risks yet seems oddly inexpensive (despite how well the stock has done in recent years) considering the competitive position of its existing businesses, excellent economics, strong brand loyalty, and future prospects.

Below, in an excerpt from a recent interview in Barron's, Michael Lippert explains why he likes Apple's business and the stock.

Lippert is manager of the Baron Opportunities Fund (BIOPX), a fund that has outperformed 99% of its peers in the past decade.

Before we look at Apple though, for some context, let's quickly look at an entirely different type of investment.

Junk bonds.

In his latest memo Howard Marks, the Chairman of Oaktree Capital, says he received a letter in January 2004 from Warren Buffett. According to the memo here's what Buffett wrote:

"I've commented about junk bonds that last year's weeds have become this year's flowers. I liked them better when they were weeds."

Warren's phrasings are always the clearest, catchiest and most on-target, and I thought this Buffettism captured the thought particularly well. Thus for Oaktree's 2004 investor conference we used the phrase 'Yesterday's Weeds...Today's Flowers' as the title of a slide depicting the snapback of high yield bonds. It showed the 45% average yield at which a sample of ten bonds could have been bought during the Enron-plus-telecom meltdown of 2002 and the 6% average yield at which they could have been sold in 2003; on average, the yields had fallen by 87% in just thirteen months.

Now, keep in mind that the extreme valuations of junk bonds also occurred during the more recent financial crisis.

They became, once again, priced for armageddon. That didn't happen.

Now they seem priced for a permanently serene world. That won't happen either.

Often a crisis or euphoria is behind the strange pricing of an asset.

What's interesting is that Apple seems not at all expensive but just does not fit that model. There is neither crisis nor euphoria surrounding the stock.

I certainly get some of the reasons behind Cisco's (CSCO) and even Microsoft's (MSFT) low valuation.

Apple is much harder to explain.

Michael Lippert points out in this Barron's interview that Apple is selling for ~10 times earnings for this year and more like 7 times expected earnings for next year.

So why is Apple valued this way?

It may be for reasons, like the junk bonds above, that have little to do with fundamentals. Who knows. I'm sure there is a good thesis or two out there why it should be cheap. One of them no doubt involves Steve Jobs and his future at Apple.

If you buy an asset with an appropriate margin of safety you don't have to know. That's the good news. There is always a good thesis out there why something deserves to be extremely cheap (or expensive). It's only after the fact that everyone seems to realize the justification was clearly nonsense. So even if you don't know specifically why something has become mispriced, the important thing is to know when enough evidence has emerged that it is mispriced and take action.

Buy at a price that leaves room for the inevitable negative surprises.

It's not like evidence of this reality doesn't pop up fairly often. Market prices for extended periods of time often have little to do with the fundamentals for any given asset.

What's surprising about this situation is that Apple's price is not extreme on the high side. Apple seems the perfect candidate to be one of the many currently over-hyped and very overvalued stocks in the market today.

So, while as an investment Apple may have very different risks than a junk bond, the reason it may be at least a bit cheap is simple:

In the short-to-intermediate run markets often misprice assets.

If you wait for it to be crystal clear the opportunity is missed. I have no idea what Apple will be worth in five or ten years but, for my portfolio, there is enough margin of safety here and possible upside to warrant some limited exposure.*

So market prices frequently have little to do with the actual economic value of an asset. Assuming there must be a logical reason for every extreme valuations can lead to missed opportunities (doing more than a little homework goes a long way). 

In the end what will matter is long-term business performance. Sometimes a business will swim with the current, other times against it. The same goes for the stock.

The reality is variation in market prices reflect changes in those currents more so than changes in intrinsic business value. Best to ignore that noise. Instead, figure out what something is conservatively worth (and, at least roughly, how it is likely to increase in intrinsic worth over time) and have the patience and discipline to decisively buy at a nice discount.

There's high correlation between business performance and the stock price in the long-run but not so much in the short run.

Adam

Long position in MSFT and CSCO established near current prices. Long positions in AAPL established at lower prices.

Related post:
Technology Stocks

* As I've said before, there's just no technology business that I'm comfortable with as a long-term investment. Occasionally, certain tech stocks have sold at enough of a discount that it made me willing to own some shares. In other words, the price was cheap enough relative to the per share cash generation (and, in some cases, net cash on the balance sheet) that it provided a substantial margin of safety. Even then I'm only willing to slowly accumulate very limited amounts. They've always been and always will be, at most, very small positions. Most are involved in exciting, dynamic, and highly competitive industries. That's precisely what makes them unattractive long-term investments. It's just too difficult to guess what the economic moat of most tech stocks will look like in the long run.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.