The portfolio outlined on April 9th, 2009* remains the same. Due to recent price increases the margin of safety on several of the stocks has unfortunately been reduced. I think they are all still selling significantly below intrinsic value, though most are now above the prices that I'd like to pay.
The portfolio consists of Wells Fargo (WFC), Diageo (DEO), Philip Morris International (PM), Pepsi (PEP), Lowe's (LOW), and American Express (AXP).
Return for the six stocks combined is 8.5%** using average market prices available for each stock on April 9th, 2009. Of course, that return is meaningless considering the short time frame. The only implications are that it is now slightly more challenging to pick up more shares. I will recommend adding to positions if market provides buying opportunities for any of these stocks and adjust cost basis accordingly.
The good news is PEP is lower and PM has not done a whole lot.
I like owning these all six of these stocks if shares can be bought at a nice discount to intrinsic value.
The idea is to own these a decade or more from now. Over the next five years may add 1-2 stocks to the portfolio. This is focus investing not trading. Lots of homework with minimal trading activity. Rarely but occasionally I may switch one of the above "core six".
Hopefully at least some of the prices on these stocks will be going down in the coming months.
As I've said previously, I do not believe this portfolio will necessarily outperform the markets in the next 2-3 years. It will definitely under-perform if we get into another one of these bubbles. Having said that, I believe this portfolio will easily outperform the market over the next decade...and just as importantly...with minimal trading activity required and lower risk.
We've seen bubbles produce the appearance of increased wealth instead of durable wealth creation. Unlike the bubbles (Commodities, Emerging Markets, Housing, Technology to name a few) of recent years one crucial difference is that the above portfolio is not only likely to go up significantly...the companies should intrinsically be worth it and provide a more durable investment platform. In other words it won't just go up...it's likely to stay there. I try to avoid the "get out before it goes over a cliff!" style of investing.
Build a portfolio with shares of businesses that are so good you can almost ignore it.
Adam
Long position in DEO, AXP, PEP, PM, WFC, and LOW
* 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 are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** As of 4/29/09.
Thursday, April 30, 2009
Tuesday, April 28, 2009
Buffett on Economic Goodwill: Berkshire Shareholder Letter Highlights
From Warren Buffett's 1983 Berkshire Hathaway (BRKa) shareholder letter:
"To see how it [accounting Goodwill] differs from economic reality, let's look at an example close at hand. We'll round some figures, and greatly oversimplify, to make the example easier to follow.
Blue Chip Stamps bought See's early in 1972 for $25 million, at which time See's had about $8 million of net tangible assets. This level of tangible assets was adequate to conduct the business without use of debt, except for short periods seasonally. See's was earning about $2 million after tax at the time, and such earnings seemed conservatively representative of future earning power in constant 1972 dollars.
Thus our first lesson: businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.
In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See's – doing it, furthermore, with conservative accounting and no financial leverage. It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill. Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry."
I believe this is the essential point that Buffett was making about Coca-Cola in this new Fortune Magazine interview. Coca-Cola earns approximately $ 7 billion after tax on GAAP tangible common equity of $ 8 billion. Do you think TCE maybe does not reflect Coca-Cola's value? Even common equity (which includes accounting Goodwill and other intangibles) comes up woefully short of correctly reflecting Coca-Cola's value.
The consumer franchise that Coca-Cola has built produces economic Goodwill that you will not find on the balance sheet.
This is a limitation of accounting...nothing more.
The better banks have similar consumer franchises and some are low cost producer's (i.e. able to obtain cheaper deposits) resulting in economic Goodwill that will not be found on the balance sheet. Simple measures like TCE ignore this economic value and can easily understate (and in some cases overstate) a bank's health. The current dialogue on the banks largely misses this reality.
The regulators, of course, can do whatever they want. It just doesn't necessarily mean that forcing a capital raise on a bank makes economic sense. Hey, some banks certainly need capital but that's not because of low TCE. It's because they lack earning power relative to the quality of their assets.
Kraft is a more crazy example since they reliably produce $ 2.5 billion of annual cash earnings with (according to GAAP) TCE of $ -18 billion (Yes negative. Quick...bring in the regulators...they are bankrupt). Yet a conservative capitalized economic value of Kraft today is north of $ +30 billion.
So either accounting has its limits or, using the Kraft example, we live in a world where someone will pay you $ 18 billion to take a likely to grow perpetuity of $ 2.5 billion in future annualized cash earnings off their hands.
Adam
Long BRKb
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"To see how it [accounting Goodwill] differs from economic reality, let's look at an example close at hand. We'll round some figures, and greatly oversimplify, to make the example easier to follow.
Blue Chip Stamps bought See's early in 1972 for $25 million, at which time See's had about $8 million of net tangible assets. This level of tangible assets was adequate to conduct the business without use of debt, except for short periods seasonally. See's was earning about $2 million after tax at the time, and such earnings seemed conservatively representative of future earning power in constant 1972 dollars.
Thus our first lesson: businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.
In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See's – doing it, furthermore, with conservative accounting and no financial leverage. It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill. Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry."
I believe this is the essential point that Buffett was making about Coca-Cola in this new Fortune Magazine interview. Coca-Cola earns approximately $ 7 billion after tax on GAAP tangible common equity of $ 8 billion. Do you think TCE maybe does not reflect Coca-Cola's value? Even common equity (which includes accounting Goodwill and other intangibles) comes up woefully short of correctly reflecting Coca-Cola's value.
The consumer franchise that Coca-Cola has built produces economic Goodwill that you will not find on the balance sheet.
This is a limitation of accounting...nothing more.
The better banks have similar consumer franchises and some are low cost producer's (i.e. able to obtain cheaper deposits) resulting in economic Goodwill that will not be found on the balance sheet. Simple measures like TCE ignore this economic value and can easily understate (and in some cases overstate) a bank's health. The current dialogue on the banks largely misses this reality.
The regulators, of course, can do whatever they want. It just doesn't necessarily mean that forcing a capital raise on a bank makes economic sense. Hey, some banks certainly need capital but that's not because of low TCE. It's because they lack earning power relative to the quality of their assets.
Kraft is a more crazy example since they reliably produce $ 2.5 billion of annual cash earnings with (according to GAAP) TCE of $ -18 billion (Yes negative. Quick...bring in the regulators...they are bankrupt). Yet a conservative capitalized economic value of Kraft today is north of $ +30 billion.
So either accounting has its limits or, using the Kraft example, we live in a world where someone will pay you $ 18 billion to take a likely to grow perpetuity of $ 2.5 billion in future annualized cash earnings off their hands.
Adam
Long BRKb
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, April 27, 2009
Coca-Cola vs Kraft
In this new Fortune article, Buffett states that Coca-Cola (KO) has no Tangible Common Equity (TCE).
I believe he could have just as easily said Kraft (KFT).
It turns out that Kraft has approximately minus $ 18B of TCE while Coca-Cola has plus $ 8 billion. In both cases, the accounting captures only a portion of economic Goodwill and that makes TCE or even (Common Equity) poor measures of the economic value. The fact that economic Goodwill matters more than accounting Goodwill is something Buffett wrote about at the end of the 1983 Letter to Shareholders.
The durable earning power of the franchise over time tells you more about a company's strength than TCE or any other simple snapshot measurement.
I've said before that this is more about the inherent limitations of accounting.
Adam
Long position in KO and KFT
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.
I believe he could have just as easily said Kraft (KFT).
It turns out that Kraft has approximately minus $ 18B of TCE while Coca-Cola has plus $ 8 billion. In both cases, the accounting captures only a portion of economic Goodwill and that makes TCE or even (Common Equity) poor measures of the economic value. The fact that economic Goodwill matters more than accounting Goodwill is something Buffett wrote about at the end of the 1983 Letter to Shareholders.
The durable earning power of the franchise over time tells you more about a company's strength than TCE or any other simple snapshot measurement.
I've said before that this is more about the inherent limitations of accounting.
Adam
Long position in KO and KFT
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.
Sunday, April 26, 2009
Is Tangible Common Equity Overhyped?
Some, including Warren Buffett, seem to think it is. I covered this to an extent in a recent post.
From this recent article by Tom Brown on the limits of tangible common equity (TCE):
Coca-Cola, Buffett notes, has no tangible equity at all, and nobody seems upset. Yet for some reason the number has become the most important statistic in banking. As regards Wells Fargo's notoriously low TCE ratio, in particular, Buffett isn't bothered:
"To the extent that [Wells Fargo's] tangible common equity is low, a) nobody was even talking about that a year ago. And b) they should be talking about earning power."
Precisely. And earnings power, in turn, is determined by the cost and stickiness of your deposits and the quality of your assets. What you name the various slices of your capital base is pretty much beside the point.
Or would be beside the point, except that the market's new emphasis on tangible capital now threatens to lead to a government semi-takeover of some of the country's biggest banks.
Tangible common equity (TCE) is just one measure and totally insufficient as "the" measure of bank health. It's just one static frame in a movie that tells you little about a bank's asset quality or capacity to use earnings over time to absorb future losses.
Warren Buffett on Wells Fargo
Example - Bank A could theoretically still have a high TCE but a bunch of poorly underwritten, risky, asset time bombs on its balance sheet while bank B has low TCE but incredibly rigorous underwriting standards and a balance sheet full of low risk assets. Also, all else equal, Bank A may have an expensive deposit base and lower net interest income (i.e. lower return on assets) while bank B has a low cost deposit base and high net interest income (i.e. higher return on assets). In this case, bank B would clearly be the stronger bank but if static TCE is the main criteria it would do worse on the stress test. That makes no sense.
What makes sense to me is this: If a bank demonstrates it can build capital the old fashioned way (via earnings over time using the harshest stress test assumptions) it would not be required to raise capital even if the current capital ratios are a bit on the low side.
Adam
Long position in Wells Fargo
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.
From this recent article by Tom Brown on the limits of tangible common equity (TCE):
Coca-Cola, Buffett notes, has no tangible equity at all, and nobody seems upset. Yet for some reason the number has become the most important statistic in banking. As regards Wells Fargo's notoriously low TCE ratio, in particular, Buffett isn't bothered:
"To the extent that [Wells Fargo's] tangible common equity is low, a) nobody was even talking about that a year ago. And b) they should be talking about earning power."
Precisely. And earnings power, in turn, is determined by the cost and stickiness of your deposits and the quality of your assets. What you name the various slices of your capital base is pretty much beside the point.
Or would be beside the point, except that the market's new emphasis on tangible capital now threatens to lead to a government semi-takeover of some of the country's biggest banks.
Tangible common equity (TCE) is just one measure and totally insufficient as "the" measure of bank health. It's just one static frame in a movie that tells you little about a bank's asset quality or capacity to use earnings over time to absorb future losses.
Warren Buffett on Wells Fargo
Example - Bank A could theoretically still have a high TCE but a bunch of poorly underwritten, risky, asset time bombs on its balance sheet while bank B has low TCE but incredibly rigorous underwriting standards and a balance sheet full of low risk assets. Also, all else equal, Bank A may have an expensive deposit base and lower net interest income (i.e. lower return on assets) while bank B has a low cost deposit base and high net interest income (i.e. higher return on assets). In this case, bank B would clearly be the stronger bank but if static TCE is the main criteria it would do worse on the stress test. That makes no sense.
What makes sense to me is this: If a bank demonstrates it can build capital the old fashioned way (via earnings over time using the harshest stress test assumptions) it would not be required to raise capital even if the current capital ratios are a bit on the low side.
Adam
Long position in Wells Fargo
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.
Charles Mackay
Sound familiar?
"Money, again, has often been a cause of the delusion of the multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper."
This quote is by Charles Mackay, who wrote "Extraordinary Popular Delusions and the Madness of Crowds" back in 1841.
In it, he describes the South Sea Company bubble (early 1700's), the Mississippi Company bubble (early 1700's), and the Dutch Tulip Mania (early 1600's) -- among other things.
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.
"Money, again, has often been a cause of the delusion of the multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper."
This quote is by Charles Mackay, who wrote "Extraordinary Popular Delusions and the Madness of Crowds" back in 1841.
In it, he describes the South Sea Company bubble (early 1700's), the Mississippi Company bubble (early 1700's), and the Dutch Tulip Mania (early 1600's) -- among other things.
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.
Jeremy Grantham
If you've never read Jeremy Grantham before...check out his 4th quarter letter. Great stuff that's full of insights.
Grantham previously called the 2003-2007 period "the biggest sucker rally in history". Most think of him as a perma-bear because he has seen stocks as being overvalued since the late 1990's.
Like Buffett, many said he did not "get it" back in then.
Recently, he's turned relatively bullish (for him) on stocks for the first time in over a decade.
By the way, that "suckers rally" delayed the chance to buy stocks (with a reasonable margin of safety) for over five years. The general over-valuation of stocks for the past decade meant that most passive investors were(via 401k, IRA etc) systematically overpaying for equities. Stocks may still go down (I have no idea) from here but, at least, many are selling near or even below fair value for the first time since the early 1990's. In the long run stocks will track growth in intrinsic value. We are at least close to being back on the trend line.
Unfortunately, I'm guessing many who should be buying now will avoid the market after the experience of the past decade. In 1999, most people felt pretty good owning stocks at the worst possible time to buy. It's called the tech bubble for good reason but at the time, GE and Coke were selling at valuations north of 50x normalized earnings. So the over-valuations were not isolated to technology by any means. Today companies like GE and Coke sell at more like 12-14x.
So unlike 1999 it feels pretty terrible to own equities...we'll see if that means some money can be made over the next decade.
I'm looking forward to Grantham's 1Q letter.
Grantham previously called the 2003-2007 period "the biggest sucker rally in history". Most think of him as a perma-bear because he has seen stocks as being overvalued since the late 1990's.
Like Buffett, many said he did not "get it" back in then.
Recently, he's turned relatively bullish (for him) on stocks for the first time in over a decade.
By the way, that "suckers rally" delayed the chance to buy stocks (with a reasonable margin of safety) for over five years. The general over-valuation of stocks for the past decade meant that most passive investors were(via 401k, IRA etc) systematically overpaying for equities. Stocks may still go down (I have no idea) from here but, at least, many are selling near or even below fair value for the first time since the early 1990's. In the long run stocks will track growth in intrinsic value. We are at least close to being back on the trend line.
Unfortunately, I'm guessing many who should be buying now will avoid the market after the experience of the past decade. In 1999, most people felt pretty good owning stocks at the worst possible time to buy. It's called the tech bubble for good reason but at the time, GE and Coke were selling at valuations north of 50x normalized earnings. So the over-valuations were not isolated to technology by any means. Today companies like GE and Coke sell at more like 12-14x.
So unlike 1999 it feels pretty terrible to own equities...we'll see if that means some money can be made over the next decade.
I'm looking forward to Grantham's 1Q letter.
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.
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, April 24, 2009
Mohawk Industries
Mohawk (MHK) is a floor covering business that I like quite a bit. It along with competitor Shaw Industries control more than 40% of the $ 20 billion+ US floor-covering market. MHK's market share has been increasing over the past decade. It has broad distribution and product breadth in an industry that continues to consolidate around the two dominant players. The economics appear to be very good for the leaders in this industry.
Of course, it is a very cyclical industry and the past 2 years have been tough. Similar to other cyclical businesses, MHK's stock will routinely drop 50-80% from peak to trough during a business cycle (the intrinsic value certainly does not..that's more steady than Mr Market). However, if you buy it at a fair price during recessions I believe MHK makes a great complimentary holding to the more steady businesses out there.
So this one's likely to be a bit more exciting than the P&G's of the world.
Yesterday's impressive forecast of 2Q earnings may hint that things are getting better in housing related businesses. The current quarter loss looks ugly (being a cyclical business that's the nature of the beast) but management's forecast of 2Q looks like the business environment may be stabilizing. You can't buy businesses like MHK based upon Price/Earnings (In fact, in my view you cannot buy any business based solely upon P/E...but that's another discussion). Companies like MHK always look expensive on a P/E basis during recessions and cheap at the peak of an economic expansion. In reality just the opposite is true. As a result, what makes something like this tricky to value with an appropriate margin of safety is you either have to:
1) discount normalized future earning power
or
2) buy when the company's P/E looks expensive (as a result of a temporarily depressed earnings in a recession...P/E may go to infinity as the E disappears for a while) and sell when it looks cheap (due to inflated earnings that are not sustainable throughout the business cycle).
I prefer the 1st method.
It's too late to buy MHK considering the size of today's move. The opportunity cost of sucking one's thumb instead of buying promptly can be just as real as the paper losses. Unfortunately, satisfaction with gains is not symmetrical with the dislike of losses. Waiting to see how Thursday's earnings report would go seemed like a good idea. I will continue to watch it and hope for a pull back.
Not acting decisively when you think you have a good idea can be costly.
In my view, MHK will easily go up a factor of 5 (trough to peak) during a full business cycle. The trough was ~$ 17/share (so far). Currently, it is selling in the mid $ 40's/share. At today's price MHK does not have sufficient margin of safety.
I'd expect future intrinsic value to grow to $90-100/share within 5 years (as I've said in previous posts I am not talking about the stock price but what I believe the company will be worth). I put MHK's current intrinsic value at $ 60-70/share.
The challenge with owning a cyclical business is ignoring the paper losses and volatility. With the inherently higher risks (both business specific and the current economic environment) I'd want to buy this at a 50% discount to intrinsic value. So we'll see if it gets below $ 35 again. If not...I missed it.
Adam
Long MHK
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.
Of course, it is a very cyclical industry and the past 2 years have been tough. Similar to other cyclical businesses, MHK's stock will routinely drop 50-80% from peak to trough during a business cycle (the intrinsic value certainly does not..that's more steady than Mr Market). However, if you buy it at a fair price during recessions I believe MHK makes a great complimentary holding to the more steady businesses out there.
So this one's likely to be a bit more exciting than the P&G's of the world.
Yesterday's impressive forecast of 2Q earnings may hint that things are getting better in housing related businesses. The current quarter loss looks ugly (being a cyclical business that's the nature of the beast) but management's forecast of 2Q looks like the business environment may be stabilizing. You can't buy businesses like MHK based upon Price/Earnings (In fact, in my view you cannot buy any business based solely upon P/E...but that's another discussion). Companies like MHK always look expensive on a P/E basis during recessions and cheap at the peak of an economic expansion. In reality just the opposite is true. As a result, what makes something like this tricky to value with an appropriate margin of safety is you either have to:
1) discount normalized future earning power
or
2) buy when the company's P/E looks expensive (as a result of a temporarily depressed earnings in a recession...P/E may go to infinity as the E disappears for a while) and sell when it looks cheap (due to inflated earnings that are not sustainable throughout the business cycle).
I prefer the 1st method.
It's too late to buy MHK considering the size of today's move. The opportunity cost of sucking one's thumb instead of buying promptly can be just as real as the paper losses. Unfortunately, satisfaction with gains is not symmetrical with the dislike of losses. Waiting to see how Thursday's earnings report would go seemed like a good idea. I will continue to watch it and hope for a pull back.
Not acting decisively when you think you have a good idea can be costly.
In my view, MHK will easily go up a factor of 5 (trough to peak) during a full business cycle. The trough was ~$ 17/share (so far). Currently, it is selling in the mid $ 40's/share. At today's price MHK does not have sufficient margin of safety.
I'd expect future intrinsic value to grow to $90-100/share within 5 years (as I've said in previous posts I am not talking about the stock price but what I believe the company will be worth). I put MHK's current intrinsic value at $ 60-70/share.
The challenge with owning a cyclical business is ignoring the paper losses and volatility. With the inherently higher risks (both business specific and the current economic environment) I'd want to buy this at a 50% discount to intrinsic value. So we'll see if it gets below $ 35 again. If not...I missed it.
Adam
Long MHK
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, April 23, 2009
Staples vs Cyclicals
According to Jack Meyer, who managed the endowment, pension, and other assets as President and CEO of the Harvard Management Company from 1990 to 2005, investors wrongly think they'll be able to identify money managers that will deliver above average results:
"Most people think they can find managers who can outperform, but most people are wrong. I will say that 85 percent to 90 percent of managers fail to match their benchmarks. Because managers have fees and incur transaction costs, you know that in the aggregate they are deleting value. The investment business is a giant scam."
Now, buying -- ideally when very cheap or, at least, a plain discount to value -- then owning long-term the shares of some high quality businesses like Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), Philip Morris International (PM), and Diageo (DEO) offer a more simple (if not easy) alternative.* Their likely long run advantages, especially adjusted for the risk of permanent capital loss, aren't small. As it stands right now, the shares of these businesses seem to be selling at very reasonable recent prices relative to current per share intrinsic value. How long the window remains open -- where a margin of safety exists -- is naturally impossible to know. I've mentioned before that, even if shares of businesses like this do not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.
So does the reduced likelihood of permanent capital loss and more narrow range of outcomes. In fact, if the quality franchises produced merely market returns they'd still win in my book. The reason is that, if bought well, the same return will have been arguably achieved at less risk of permanent capital loss (not temporary paper losses).
Though each franchise has its own unique risks, these generally have, give or take, attractive business economics and future prospects. The durability of their advantages is more understandable than most other businesses in my view.
It is a totally different situation for market participants who's primary focus is the trading of price action.
Anyone buying the higher quality stocks expecting them to outperform during the next bull market is likely to be disappointed. That is, in part, how they have earned the reputation of being defensive. Yet, this reputation is verifiably incorrect when you look at the historic returns of these stocks over the longer haul (a full business cycle or two). Over shorter time frames, it's easy to see why these are perceived to be defensive investments. They generally don't go down as much when the market crashes, and they don't go up as fast during bull markets. It's over a number of bull and bear markets that their merits -- especially if adjusted for risk -- become more obvious. And when I say adjusted for risk I don't mean beta. I mean the risk of permanent capital loss (not near-term paper losses).
They tend to just quietly work out okay in the long run with little or no trading required. Of course, buying with a margin of safety is still very important. As I've said, what's sensible to buy at a plain discount to intrinsic value won't make sense at some materially higher valuation.
What really matters is, of course, how these businesses and ultimately their shares will perform going forward. Getting that at least mostly right still requires plenty of work.
In other words, just because something has done well in the past guarantees nothing.
Also, attempting to trade them based upon market conditions seems very likely to only hurt long-term results between the added frictional costs and mistakes that get made.
So look elsewhere for exciting stock market price action.
Some of the more cyclical sectors that are down 70-80% will outperform during the next bull market. Just keep in mind that you are taking more risk and, ultimately, many of these more economically-sensitive businesses are inferior in the long run.
That doesn't mean shares of all economically-sensitive businesses are inferior. There are some good ones. LOW, WFC, and AXP are examples I've mentioned in the past that I like for my own portfolio.
(As always, I never have an opinion on what others should or should not own.)
I've said previously...
Some commentators seem to suggest it's possible to jump in and out the shares of a high quality business based upon whether a defensive posture is warranted or not.
Well, correctly doing this without making mistakes (and creating unnecessary frictional costs) seems like a good idea mostly in theory, less so in practice.
As Jack Meyer points out above, a number of professional managers -- though certainly not all -- will perform poorly against benchmarks like the S&P 500 in the long run. Defensive stocks, on the other hand, tend to do just fine if bought cheap enough and held for a longer time period.
(Over the shorter run -- less than five years or so -- anything can happen as far as relative performance goes, of course.)
At a minimum, I'd argue this deserves more attention than it gets.
That doesn't mean no one can successfully time the market. I'm guessing there are some who effectively do that sort of thing. It's just that the evidence suggests the odds are not good when you include all the frictional costs involved and seemingly inevitable mistakes (every additional move isn't just a chance to improve results...it's a chance to make a mistake and hurt results). Also, identifying the managers who will actually do well long into the future is difficult at best.
Buy great companies at a fair (or better than fair) price. Otherwise, try to ignore the near-term -- or even intermediate-term -- market fluctuations and stock price action.
Finally, if someone is able to spot the next Google, Apple -- the next big thing -- they should go for it.
I have no idea how to do that without making costly mistakes.
Adam
Related posts:
Best and Worst Performing DJIA Stock
Defensive Stocks?
* Long positions in KO, PEP, PG, PM, and DEO. My preference happens to be PM and DEO but consider each of these long positions to be worthy investments when bought at the right price.
---
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.
"Most people think they can find managers who can outperform, but most people are wrong. I will say that 85 percent to 90 percent of managers fail to match their benchmarks. Because managers have fees and incur transaction costs, you know that in the aggregate they are deleting value. The investment business is a giant scam."
Now, buying -- ideally when very cheap or, at least, a plain discount to value -- then owning long-term the shares of some high quality businesses like Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), Philip Morris International (PM), and Diageo (DEO) offer a more simple (if not easy) alternative.* Their likely long run advantages, especially adjusted for the risk of permanent capital loss, aren't small. As it stands right now, the shares of these businesses seem to be selling at very reasonable recent prices relative to current per share intrinsic value. How long the window remains open -- where a margin of safety exists -- is naturally impossible to know. I've mentioned before that, even if shares of businesses like this do not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.
So does the reduced likelihood of permanent capital loss and more narrow range of outcomes. In fact, if the quality franchises produced merely market returns they'd still win in my book. The reason is that, if bought well, the same return will have been arguably achieved at less risk of permanent capital loss (not temporary paper losses).
Though each franchise has its own unique risks, these generally have, give or take, attractive business economics and future prospects. The durability of their advantages is more understandable than most other businesses in my view.
It is a totally different situation for market participants who's primary focus is the trading of price action.
Anyone buying the higher quality stocks expecting them to outperform during the next bull market is likely to be disappointed. That is, in part, how they have earned the reputation of being defensive. Yet, this reputation is verifiably incorrect when you look at the historic returns of these stocks over the longer haul (a full business cycle or two). Over shorter time frames, it's easy to see why these are perceived to be defensive investments. They generally don't go down as much when the market crashes, and they don't go up as fast during bull markets. It's over a number of bull and bear markets that their merits -- especially if adjusted for risk -- become more obvious. And when I say adjusted for risk I don't mean beta. I mean the risk of permanent capital loss (not near-term paper losses).
They tend to just quietly work out okay in the long run with little or no trading required. Of course, buying with a margin of safety is still very important. As I've said, what's sensible to buy at a plain discount to intrinsic value won't make sense at some materially higher valuation.
What really matters is, of course, how these businesses and ultimately their shares will perform going forward. Getting that at least mostly right still requires plenty of work.
In other words, just because something has done well in the past guarantees nothing.
Also, attempting to trade them based upon market conditions seems very likely to only hurt long-term results between the added frictional costs and mistakes that get made.
So look elsewhere for exciting stock market price action.
Some of the more cyclical sectors that are down 70-80% will outperform during the next bull market. Just keep in mind that you are taking more risk and, ultimately, many of these more economically-sensitive businesses are inferior in the long run.
That doesn't mean shares of all economically-sensitive businesses are inferior. There are some good ones. LOW, WFC, and AXP are examples I've mentioned in the past that I like for my own portfolio.
(As always, I never have an opinion on what others should or should not own.)
I've said previously...
Some commentators seem to suggest it's possible to jump in and out the shares of a high quality business based upon whether a defensive posture is warranted or not.
Well, correctly doing this without making mistakes (and creating unnecessary frictional costs) seems like a good idea mostly in theory, less so in practice.
As Jack Meyer points out above, a number of professional managers -- though certainly not all -- will perform poorly against benchmarks like the S&P 500 in the long run. Defensive stocks, on the other hand, tend to do just fine if bought cheap enough and held for a longer time period.
(Over the shorter run -- less than five years or so -- anything can happen as far as relative performance goes, of course.)
At a minimum, I'd argue this deserves more attention than it gets.
That doesn't mean no one can successfully time the market. I'm guessing there are some who effectively do that sort of thing. It's just that the evidence suggests the odds are not good when you include all the frictional costs involved and seemingly inevitable mistakes (every additional move isn't just a chance to improve results...it's a chance to make a mistake and hurt results). Also, identifying the managers who will actually do well long into the future is difficult at best.
Buy great companies at a fair (or better than fair) price. Otherwise, try to ignore the near-term -- or even intermediate-term -- market fluctuations and stock price action.
Finally, if someone is able to spot the next Google, Apple -- the next big thing -- they should go for it.
I have no idea how to do that without making costly mistakes.
Adam
Related posts:
Best and Worst Performing DJIA Stock
Defensive Stocks?
* Long positions in KO, PEP, PG, PM, and DEO. My preference happens to be PM and DEO but consider each of these long positions to be worthy investments when bought at the right price.
---
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, April 22, 2009
Tangible Common Equity
Every since Mr Market decided suddenly that Tangible Common Equity (TCE) was THE measure of a bank's health a couple of months ago I've been well...amazed. It's another great example of how some investors and media outlets can just grab onto something whether or not it makes sense.
Some think TCE is the focus of the bank stress tests. If it turns out the basis of the stress testing is to use this simplistic and flawed measure of bank health -- and, as a result, some of the better banks are forced to raise lots of capital at a discount to per share value -- that will be unfortunate.
Just a guess but I think we will find out the tests look at a more comprehensive set of measurements.
In this interview in Fortune Magazine, Warren Buffett had this to say about TCE as a measure of bank health:
"You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where’d the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've (Wells) got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently." - Warren Buffett
We should know the answer soon.
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.
Some think TCE is the focus of the bank stress tests. If it turns out the basis of the stress testing is to use this simplistic and flawed measure of bank health -- and, as a result, some of the better banks are forced to raise lots of capital at a discount to per share value -- that will be unfortunate.
Just a guess but I think we will find out the tests look at a more comprehensive set of measurements.
In this interview in Fortune Magazine, Warren Buffett had this to say about TCE as a measure of bank health:
"You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where’d the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've (Wells) got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently." - Warren Buffett
We should know the answer soon.
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.
Warren Buffett on Charlie Munger
Warren Buffett on his vice chairman:
"When I call Charlie with an idea...and he says, 'That is really a dumb idea,' that means we should put 100% of our net worth into it. If he says, 'That is the dumbest thing I've ever heard,' then you should put 50% of your net worth into it. Only if he says, 'I'm going to have you committed,' does it mean he really doesn't like the idea."
Seems to have worked pretty well for them.
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.
"When I call Charlie with an idea...and he says, 'That is really a dumb idea,' that means we should put 100% of our net worth into it. If he says, 'That is the dumbest thing I've ever heard,' then you should put 50% of your net worth into it. Only if he says, 'I'm going to have you committed,' does it mean he really doesn't like the idea."
Seems to have worked pretty well for them.
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.
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