If Buffett Were Paid Like a Hedge Fund Manager

It's well known that Warren Buffett is paid $ 100,000 per year (excluding security costs) to manage what is now a $ 150 billion portfolio and the operating company* for Berkshire Hathaway (BRKa) shareholders.

The operating company alone employs 260,000 people and earned $12.9 billion last year.

Now, consider that the sum of all salary received by Buffett over of the past 40 years or so is actually less than half what the highest earning hedge fund manager made in a day last year.

No kidding.

The increases to Buffett's wealth has come from gains in the value of the Berkshire shares he owned after ending his investing partnerships in 1969. His business skills and capital allocation talents driving the substantial increase in Berkshire's value since then. So, unlike a hedge fund manager, Buffett gets no fees nor other forms of compensation like bonuses, stock grants or options or from Berkshire Hathaway. Just what is, at least in this context, a token salary.

My focus here is not on that contrast in compensation. I think the contrast speaks for itself. I think what's far more interesting than that crazy gap in pay is the impact extremely high compensation has on potential shareholder returns. More importantly, the compensation systems most prevalent these days are likely expensive in a broader sense (beyond the walls of Berkshire or any hedge fund).

Some quick background and context:

Hedge Fund Pay
The 25 best paid hedge fund managers made a combined $22 billion last year which was actually down from the year before. The top person in pay was John Paulson at $ 4.9 billion ("yeah, that's right" as David Puddy from Seinfeld would say).

Article: Hedge Fund Pay Down in 2010

10. Paul Tudor Jones (Tudor Investment Corp): 440 million

9. George Soros (Soros Fund Management): 450 million

8. Bruce Kovner (Caxton Associates): 640 million

7. Carl Icahn (Icahn Management): 900 million

6. Eddie Lampert (ESL Investments): 1.1 billion

5. Steve Cohen (SAC Capital): 1.3 billion

4. David Tepper: 2.2 billion

3. Jim Simons (Renaissance Technologies): 2.5 billion

2. Ray Dalio (Bridgewater Associates): 3.1 billion

1. John Paulson (Paulson and Co): 4.9 billion

What I'd like to focus on here is not the gains that come from the money these managers have invested in their funds (especially if those invested funds DID NOT come from the accumulated fees charges in prior years) but, instead, on the money made from the hedge fund industry standard "2 and 20" compensation structure.
(This type of compensation structure includes a management fee that's 2% of assets under management. It also includes, when applicable, a performance fee for 20% of the profits -- sometimes above a certain threshold -- or some similar variation.)

A good chunk of the above earnings comes from fees though, of course, this varies greatly by fund.

To keep this simple but meaningful, let's consider a hedge fund with $ 20 billion in assets under management (excluding what the fund manager has kept invested in the fund). Many of the larger hedge funds have more than that much under management -- some much more -- so it's a reasonable scenario.

Now, in a year where a hedge fund generates, let's say, a 10% return -- what is, of course, a $ 2 billion increase -- that means the frictional costs for investors in would roughly be:

2% of $ 21 billion plus = $ 420 million
(The fund would have increased from $ 20 to $ 22 billion so I've used the midpoint.)

and

20% of the $ 2 billion profit = $ 400 million

= $ 820 million

These rather huge frictional costs couldn't contrast more greatly with the model that exists within the Berkshire.**

Now let's look at how the above compensation structure, if adopted, would have impacted Berkshire.

Berkshire Hathaway
Berkshire Hathaway has come a long way from the New England textile company Buffett bought in the 1960s.

Back then Berkshire was definitely no earnings powerhouse.

In fact, it was not a good business at all.

In contrast to the shaky Berkshire of the early 1960s, it is now a capital producing machine with a collection of mostly wide moat businesses, equities, and other investments.

Now, let's consider a kind of "Bizarro" Buffett scenario.

This version of Buffett is equally talented at capital allocation with a key difference.

Instead of accepting the $ 100,000 annual paycheck -- a salary he's, in fact, been paid for quite a long time -- this Buffett is paid via the "2 and 20" compensation structure. The kind of arrangement (or some variation) that generated a good chunk of the earnings for the above hedge fund managers. This Buffett does not reinvest those fees back into Berkshire Hathaway either.

Under these circumstances, how much would Berkshire Hathaway be worth today?

No where near its current market value of $ 195 billion.
(For simplicity, let's set aside the question whether the market value represents anything close to Berkshire's intrinsic value.)

In fact, it'd likely be worth more like roughly $ 20 billion.

One-tenth or so its current value.

So, a businesses worth ~$ 195 billion today that employs 260,000 people likely ends up something like 1/10th or so its current size due to the "2 and 20" frictional costs. (This is easy to calculate. Just subtract the "2 and 20"  fees from Berkshire's returns since it was purchased to come up with the approximate compounded effect. The exact number would depends at what level of profits the 20% kicks in. That seems like splitting hairs. The effective outcome ends up being still roughly the same...give or take, an order of magnitude difference in value.)

Not only does this version of Buffett not reinvest those fees back into Berkshire, he happens to also be a gold bug. All the capital he extracts in fees goes into the yellow metal.

The net effect is that Berkshire's long-term shareholders end up with ~ 1/10th the amount in wealth and, since Buffett buys only gold in his personal account, the benefits of his skills at capital and resource allocation do not extend beyond the walls of Berkshire.***

It's worth pointing out that, in this scenario, Buffett is clearly worse off as well. The returns from his gold, minus the frictional costs (incl. taxation), plus his ownership of the much smaller Berkshire almost certainly wouldn't come close to his current wealth (though, no doubt, some might argue under certain circumstances gold could perform exceptionally well). Even if, instead of buying gold, this Bizarro Buffett bought as much Berkshire stock as possible using the "2 and 20" fees from the new compensation arrangement, he would likely still be far worse off.

Why?

Because Berkshire itself is now worth so much less. An enterprise depleted of capital in the form of fees, grows its intrinsic value at a lower rate, and ends up a shadow of its potential self.****

An order of magnitude difference in earning power, capacity to invest, and ability to employ.

Buffett would own a much bigger percentage of the entity, but the entity would be worth intrinsically far less.
(Even at 100% ownership of the much smaller Berkshire's stock, it wouldn't equal his current partial ownership of the much bigger entity.)

So this would obviously be very costly to Buffett and Berkshire's other shareholders but I think the reality is the costs extend much further.

I'll get to that in a follow up post.

Adam

Long BRKb

Related post:
If Buffett Were Paid Like a Hedge Fund Manager - Part II (follow up)
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again

* The operating businesses that Berkshire owns outright include: GEICO, General Re, National Indemnity, MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of The Loom, Russel Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking, among others. These businesses generated the bulk of those $ 12.9 billion in earnings. So it's not a hedge fund but obviously Berkshire owns and manages much more than even the largest among them.
** Buffett was paid $ 100,000 last year but did not get any stock grants, stock options, or bonuses. An apples-to-apples comparison to hedge fund frictional costs would also include the operating costs of Berkshire's corporate office (though much of those costs are presumably related to the operating businesses Berkshire owns outright) and related (that now also would include the costs related to Todd Combs, the new investment manager). Buffett does have personal and home security paid for by Berkshire. Consider how small these costs are in the context of Berkshire overall. The difference in frictional costs is still measured in orders of magnitude compared to a typical hedge fund. So let's not split hairs. The difference, I think, speaks for itself. Precision not required. Berkshire has been built to minimize frictional costs for investors like few other investment vehicles. Of course, during Buffett's partnership era, the fee structure was lucrative for him on the upside but also gave him exposure to losses on the downside. In fact, he could lose more money than he invested into the partnership by covering some of all losses from his partners. From Alice Schroeder's book, The Snowball: "I got half the upside above a four percent threshold, and I took a quarter of the downside myself. So if I broke even, I lost money. And my obligation to pay back losses was not limited to my capital. It was unlimited." (pp. 201-202)
*** It's not as if the money disappears but whoever Buffett buys gold from may or may not take Buffett's cash and allocate it wisely. Those dollars could end up invested in something useful and productive just as easily as it could end up in something like so-called AAA mortgage backed securities circa 2005, the IPO for pets.com, or maybe just plain old consumption. The point is it'd be hard to argue that, as far as capital allocation goes, the money will be in the hands of someone better at it. The world is not made up of equally wise capital allocators. Of course, the real Buffett would certainly not be buying a non-productive asset like gold. He'd most likely use those "2 and 20" fees to make big returns for himself -- and maybe others -- separate from Berkshire and its shareholders. It's true that eventually the money, as it flows through the economy, will likely end up invested intelligently at some point. There is, if nothing else, a delay. Well, since there's a time value of money, that alone is a real cost. So the delay is, in itself, expensive on a compounded basis over the longer haul. The specific cost may not be easy to measure but, ultimately, this dynamic seems likely to at least slow the rate of increase to living standards and wealth creation. It's just that these frictional costs, at the very least, diffuse and delay effective capital formation and allocation. Capital needs to get in the hands of capable allocators, with a longer investment time horizon (patient capital), meaningful scale, and in a timely manner.
**** Now, if the company consistently raised capital to offset the capital depleted by those "2 and 20" fees, then theoretically it could be the same size enterprise, but the Berkshire investors not named Warren Buffett would still be far worse on a per share basis due to the dilution.
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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.

Berkshire Hathaway 1st Quarter 2011 13F-HR

The Berkshire Hathaway (BRKa) 1st Quarter 2011 13F-HR was released yesterday.

Compared to the 4th Quarter 2010 13F-HR, where more than 10 stocks were sold and Buffett continued to build his Wells Fargo (WFC) position, not much has changed.

At least not much that has yet been disclosed.

(Here is a post that summarizes changes made in the previous Berkshire Hathaway 13F-HR.)

In 1Q 2011, there was minimal selling or buying with the exception of some possible new purchase(s) that were kept confidential. The filing says: "Confidential information has been omitted from the Form 13F and filed separately with the Commission."

From time to time, the SEC allows Berkshire Hathaway to keep certain material moves confidential. The intention being to prevent buyers from driving up the price before Berkshire makes its future purchases.

Besides the mystery stock or stocks that Berkshire has been purchasing, there were the following disclosed changes to the stock portfolio:

Equities Purchased
The only entirely new position was Mastercard (MA).

A look at the cash flow statement from the most recent 10-Q reveals that $ 834 million of purchases were made in the 1st quarter.

Since the Mastercard purchase was only an estimated $ 52 million (using the midpoint of the stocks trading range that quarter) that means roughly $ 782 million of other new purchase(s) (ie. the mystery purchases) were transacted by Berkshire Hathaway during 1Q 2011.

Equities Sold
A very small but basically immaterial amount of ConocoPhillips (COP) was sold. It remains a top ten position.

Portfolio Summary
After the changes, Berkshire Hathaway's stock portfolio* is made up of ~ 43% financials, 41% consumer goods, 6% consumer services, and 5% healthcare. The remainder is primarily spread across industrials and energy.

1. Coca-Cola (KO) = $ 13.6 billion
2. Wells Fargo (WFC) = $ 9.5 billion
3. American Express (AXP) = $ 7.6 billion
4. Procter and Gamble (PG) = $ 5.1 billion
5. Kraft (KFT) = $ 3.6 billion

As is almost always the case, it's a very concentrated portfolio with the top five often making up 60-70 percent and, at times, even more of the equity portfolio.

We'll see if some of these mystery purchase(s) could be, at least in part, those of Todd Combs. Initially, Combs is expected to manage just $ 2-3 billion of the portfolio.

As of the last 10-Q (the best view available until the annual report comes out), the combined value of the Berkshire portfolio including the above equities plus fixed maturity securities and other investments is nearly $ 120 billion** (excluding cash).

In addition, there was roughly $ 41 billion in cash at the end of 1Q 2011 although $ 9 billion will be needed for the Lubrizol purchase. That pile of cash can grow easily at a rate of $ 10 billion/year so there is no shortage of money to put to work at Berkshire.

Adam

Long positions in BRKb, KO, WFC, AXP, PG, KFT and COP established at lower than recent market prices.

* Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside of the United States. The status of those shares (BYD, POSCO, Sanofi, Tesco etc.) are updated in the annual letter.
** This portfolio, of course, excludes all the non-insurance operating businesses that Berkshire owns: MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking among others. In addition, they own insurance businesses (BH Insurance, General Re, GEICO, etc.) that provide plenty of "float" for investments. See page 106 of the annual report for a full list of the operating businesses.
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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.

Jeremy Grantham's 1Q 2011 Letter

From part 2 of Jeremy Grantham's 1st Quarter 2011 letter:

Time To Be Serious (and probably too early) Once Again

"...if you are a value manager, you buy cheap assets. If you are very 'experienced,' a euphemism for having suffered many setbacks, you try hard to reserve your big bets for when assets are very cheap. But even then, unless you are incredibly lucky, you will run into extraordinarily cheap, even bizarrely cheap, assets from time to time, and when that happens you will have owned them for quite a while already and will be dripping in red ink."

Oddly inexpensive, clearly mispriced assets, (a dollar bill selling for 50 cents) often get a whole lot cheaper. It's almost a given.

Short-to-intermediate-term forces in the markets will often take what seems an extreme value already to an even further extreme.

Ultimately, favorable long-term returns will still be produced if price versus a conservative estimate of value is correctly assessed. Still, seeing some red ink on paper inevitably happens to even experienced value-oriented investors.

The idea is to pay a large discount for something that temporarily has low expectations.  If things go a bit better than expected you end up making a nice return over the long-run. If things don't get better, or even deteriorate, you don't lose much if anything because of the extremely low price paid.

That's very different from misjudging the value of something and holding on while real losses mount. Trying to get you money back if you've made a misjudgment in what something is actually worth is never wise.

Investors often try to do this and returns suffer greatly and unnecessarily as a result.

If the quoted price remains in the red, even if for an extended period, but intrinsic value was judged correctly...no big deal.

Again, as long as the stock was purchased at a clear discount to a conservative estimate of that value.

In that situation, a long-term investor can either just ignore the near term price fluctuations or buy more of the mispriced asset at an even bigger discount.

"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." - Warren Buffett

Investing is never about the short or even intermediate term price action. It's about the price paid relative to the value today and, more importantly, how the value of that asset will increase intrinsically over time.

It's the long run earning power of a productive asset.

Unfortunately, for almost all businesses it's impossible to know with any precision how the future will turn out. So less certainty obviously means a greater discount or margin of safety is needed.

Consider Coca-Cola (KO), a not particularly inexpensive stock these days but certainly among the highest quality businesses. It has excellent core economics and many durable competitive advantages. These high quality characteristics justify a smaller margin of safety than most.

25 years ago, Coca-Cola was selling for ~$ 5 bucks a share. It is now on the verge of producing nearly $ 4/share in earnings each year and that stream of earnings continues to grow. Today, the dividend alone is $ 1.88/share so in a little over every 2.5 years an investor in Coca-Cola back then now receives cash dividends equal to the price paid. How the stock of a quality business trades several years after it was bought is irrelevant to the long-term investor. With great businesses time is indeed your ally.

 So while even Coca-Cola's future is impossible to know with any certainty the next 25 years hardly looks unattractive.

Long-term investors are always dealing with balancing the risk of seeing some red ink on the computer screen for an extended period with making sure enough of a desirable asset is owned. It's no fun ending up with the quantity of "an eyedropper" when a full eight ounce glass was wanted.

So seeing some quotes in the red for a period of time goes with the territory.

The question is: if you are not selling anytime soon who cares if there's a temporary paper loss when you expect something to compound in value materially in a decade or so?
(and if it's a quality business continuing to increase in value well beyond that over time)

"Picking bottoms is not our game. Pricing is our game. And that's not so difficult. Picking bottoms is, I think, impossible." - Warren Buffett at the 2009 Berkshire Hathaway (BRKa) Shareholder Meeting

The bottom line is buying "too early" is going to happen but things work out okay if you get the price versus value right.

Adam

Long position in KO and 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.

Cisco Reports Earnings: Opportunity or Trap?

Cisco (CSCO) reported earnings yesterday and the stock is down substantially in early trading:

Barron's on Cisco Earnings

One analyst at Cannacord Genuity said we are "stepping to the sidelines on what has been a challenged thesis..."

Baird, Canaccord Cut Cisco

In contrast to that view, several money managers with good long-term track records managing actual money have been buyers of Cisco's stock in the 1st quarter. Some examples:

-Arnold Van Den Berg

-Whitney Tilson

-Donald Yacktman

-Tweedy Browne

There were also quite a few other money managers that, give or take, have a style that is some variation of Graham-Dodd or Buffett-Munger that were buyers of Cisco in 4Q 2010 at higher prices. Many of these have yet to report their 1Q 2011 holdings. It will be interesting to see if some of them have continued to add Cisco.

Obviously, all these managers could be on the wrong track but it's notable that managers who normally avoid tech stocks like the plague are buying. These managers would not have touched technology stocks a decade ago.

So who's more likely to be right, the professional money managers with long-term track records or the analysts?

In the long run I'd generally be inclined to go with the money over the mouth.

Tweedy, Browne's take on Cisco:

"Cisco is financially strong and we think statistically cheap. It has a dominant market position and has been growing within a category that we believe still has a lot of room for future growth. Perceived competitive threats and concerns about possible slower rates of growth have put pressure on Cisco's stock price, which has allowed us an entry point in the stock that we believe is at roughly a one third discount from a conservative estimate of the company's intrinsic value."

In 2003, Tweedy Brown wrote that they believed Cisco was overvalued:

"...it is a mystery to us why Cisco trades at a 68% premium to JNJ based on estimated earnings multiples."

Clearly Cisco has its share of real troubles. At the $ 16.80/share price as I write this and nearly 5 bucks ($ 4.81/share) of net cash on the balance sheet the company now has an enterprise value* that is roughly $ 12.00/share.

Even with its current difficulties, Cisco can earn nearly $ 1.50/share annually without breaking a sweat.

So you've got an 8x multiple right now** and a great opportunity for share buybacks. Cisco already has a $ 11.7 billion stock repurchase program in the works. At current prices that would erase ~13% of shares outstanding (at lower prices even more naturally).

Of course, as I've mentioned in previous posts, low multiples exist for many big cap tech names right now.

Remarkably, even Apple (AAPL) still seems not expensive.

Back to Cisco. I'm not the biggest fan of the company but eventually price matters. Let's assume the troubles get worse before they get better and earnings even go down a bit.

Charlie Munger has said that an equity investor should expect 50% drops in quoted price -- something that has happened to Berkshire multiple times -- from time to time:

"I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by say 50%." - Charlie Munger

So let's assume that a 50% drop from here happens to Cisco.

$16.80/share*.50 = $ 8.40/share

At that price they still have $ 4.81/share in cash so the enterprise value per share of the business would be:

$ 8.40/share - $4.81/share = $ 3.59/share

$ 3.59/share for an asset likely to earn something like $ 1.50/share?

At that price, the owners have a 42% earnings yield as long as management is competent enough to not throw the money earned into a furnace.

With that kind of earnings yield growth is hardly a necessity.

In fact, a simple, well-protected, mattress for the cash will do.

Now, if management actually can invest the cash intelligently that's a bonus (for starters, a buyback while the stock remains extremely low). So the simple arithmetic here provides no guarantees but at least some margin of safety unless earnings are on the verge of permanent catastrophic decline. Economic moat, destroyed. If that's the case all bets are off.

Otherwise, If bought at $16.80/share and the stock goes up the investor obviously makes money. No problem. If the stock drops by 50% but maintains anything close to that long-term earning power of $ 1.50/share it creates an enormous opportunity. Not only can the individual long-term investor accumulate more shares below intrinsic value, the company itself can buyback a larger percentage of the share count (for a given amount of dollars committed to buybacks).

Both actions, of course, will directly benefit long-term owners. So, if long-term earning power isn't impaired materially, long-term shareholders should hope for a declining stock price in the near to intermediate term. In the real world, I realize that loss aversion is potent enough that many investors have a tough time investing this way.

The key is to make sure the initial purchases made at or near the $ 16.80/share price are sized in a way that allows aggressive buying to occur at the lower prices.

That's often where the mistakes get made and opportunities are missed.

A true long-term investment time horizon is also needed.

No trades here.

The more expensive shares initially purchased near $ 16.80/share, in this scenario obviously now deeply in the red, should produce more than solid though obviously less spectacular returns for the long-term investor (though what's quoted will certainly be ugly for an extended period of time).

At that higher price Cisco still provides a 12.5% earnings yield based upon enterprise value.

Again, none of this is true if earnings are on the verge of a catastrophic sustained decline. Nor is it true if Cisco ends up needing most of its earnings to be reinvested in the business to remain competitive (or uses its funds to make expensive acquisitions). All things being equal, businesses that require lots of incremental capital to remain competitive are less attractive. Cisco historically hasn't been a capital intensive business but lots of capital has been used for acquisitions.

Ultimately, the judgment of intrinsic value has to be approximately correct and a long enough time horizon or none of this works. Other than that, it comes down to temperament, discipline and patience. The fact is many cannot stomach to see the paper losses that are an inevitable part of this process.

Try the same approach on a high flying stock selling at a 50-70x multiple of earnings that gets into trouble.

The math doesn't work.

"...many shall fall that are now in honor." - Horace

With an extreme multiple, earnings are far too small relative to the price paid to provide a useful economic cushion.

Better to buy at a price where nothing great has to happen to produce a nice return.

That's why I never buy a high multiple stock no matter how much I like the business. Every business runs into unexpected difficulties from time to time. I accept that I will not be able to predict when.  Paying a price that provides a margin of safety is your only protection from those unknowables.

"If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's important is inner peace; you have to be able to think for yourself. It's not a complicated game." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting

The reality is successful investing is mostly about making judgments on many hard to quantify intangibles and being approximately right. Elaborate financial models built with complex spreadsheets are often better at being precisely wrong.

"If you need to use a computer or calculator to make the calculation, you shouldn't buy it." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting

Maybe some smart folks get bored by arithmetic. If so it helps to explain, in part, the kind of frequent misjudgments that result in the routine extreme mispricing of assets in the market (both on the high side and low side).

Those schooled in complex statistics, detailed spreadsheets, technical analysis, algorithms, and other sophisticated "higher" forms of analysis that have become prevalent in the trading/investing world just may consider the insights revealed by arithmetic to be beneath them.

Too simple.

"...the hedge fund known as 'Long-Term Capital Management' recently collapsed, through overconfidence in its highly leveraged methods, despite IQ's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group

Judging the risk/reward profile in a situation like Cisco is never easy. There is always unknowables and uncertainties in the future for any business (especially technology businesses). Yet, eventually price gets low enough that the simple math involved wins out over all the worst case scenarios one can imagine.

At the most recent shareholder meeting, Buffett said that he and Munger keep financial projections in their heads and ignore bankers' spreadsheets.

At the meeting, Munger's advice for those in business school was this:

"At least until you're out of school you have to pretend to do it their way."

Let's hope the rapid-fire-can't-wait-a-couple-quarters-for-a-business-to-sort-itself-out culture continues to provide opportunities.

With that said, the fact is there's just no technology business that I'm comfortable with as a long-term investment. Occasionally, some have sold at enough of a discount to be worth the trouble, but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries.

That's precisely what makes them unattractive long-term investments.

Adam

Long positions in Apple and Cisco

* Enterprise Value = market capitalization - net cash.

Market Capitalization: Cisco has 5.537 billion share outstanding. At $ 16.80/share the market capitalization = $ 16.80*5.537 billion = $ 93.022 billion

Net Cash: Cisco has $ 43.367 billion of cash, cash equivalents and investments. They also have $ 16.749 billion of debt. So net cash = $ 43.367 billion -$ 16.749 billion = $ 26.618 billion

Enterprise Value = $ 93.022 billion - $ 26.618 billion = $ 66.404 billion

Enterprise Value/Share = $ 66.404 billion/5.537 billion = $ 11.993/share

** This works because the earnings are of decent quality (backed up by free cash flow) and look reasonably durable even if Cisco's earnings power shrinks a bit in the near term. There are plenty of low price to earnings stocks out there that seem cheap but are lacking earnings quality, earnings durability or both.
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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.

Fairholme's 1Q 2011 Portfolio Update: Still Dominated by Financial Stocks

Fairholme's (FAIRX) Bruce Berkowitz has had an excellent decade or so of performance but a rough go of it lately.

In 2010 Fairholme won Morningstar's Domestic-Stock Fund Manager of the Decade.

Over the ten years preceding that award, Fairholme earned a 13.2% annualized total return in a period when the S&P 500 produced slightly negative annualized returns (a 14% per year outperformance).

The latest report of Fairholme's 1Q 2011 portfolio revealed a 75% weighting in financial stocks.

In the most recent quarter Berkowitz continued to add to positions in the financials.

Completely new positions: Brookfield Asset Management (BAM), China Pacific Insurance Group (CHPXF)

Reduced positions: Spirit Aerosystems (SPR), Winthrop Realty Trust (FUR)

Closed out these positions 100%: General Growth Properties (GGP), General Electric (GE), Banco Santander (STD), Wellcare (WCG), and Teva Pharmaceuticals (TEVA)

The full audio to the shareholder conference call is here.

Quite a contrast in approach to the fund management team at the Yacktman Funds (YAFFX, YACKX).

A team that has also produced very solid results over the past decade or so.

Yacktman on "Old Tech"

The Yacktman team's emphasis has been consumer staples, media, and what they call "old tech" with only one financial stock among the top 25 holdings (U.S. Bancorp: USB).

Adam

Long GE, and USB

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.

Microsoft Buys Skype

From this Microsoft (MSFT) press release:

Microsoft to Acquire Skype

$ 8.5 billion appears to be an awful lot to pay for a business that has barely earned a penny in its eight years of existence.

Of course, eBay (EBAY) was thought to have paid too much when they paid $ 2.6 billion for Skype in 2005. They bought it with the idea that eBay buyers and sellers would use it to communicate. It didn't work out.

Appearing to admit defeat, eBay then sold a 70% stake to a consortium led by Silver Lake Partners for $ 1.9 billion in 2009. So at that time Skype was valued at $2.75 billion. (70% of a $ 2.75 billion valuation = $ 1.9 billion in cash to eBay*).

eBay retained the remaining approximately 30% equity investment in Skype.

Well that remaining 30% stake that eBay still owns is now worth ~$ 2.6 billion based upon the $ 8.5 billion Microsoft is paying. So while the experiment with Skype didn't work out eBay has financially more than reversed the error.

eBay initially paid $ 2.6 billion (plus $ 500 million in earnouts) back in 2005.

Between the two transactions (the initial Silver Lake led deal and now Microsoft) eBay gets:

~$ 1.9 billion (from Silver Lake back in 2009)

plus

~$ 2.6 billion (Microsoft)

= $ 4.5 billion.

So eBay ultimately did a whole lot better than others probably imagined a few years ago. It still was not a great use of capital by them when you look at opportunity costs but at least no longer a disaster.

Meanwhile, Silver Lake Partners and the other investors sure did alright.

Time will tell whether this makes any sense for Microsoft.

Wall Street Journal article: Microsoft to Acquire Skype

TechCrunch article: Done Deal! Big Deal. Smart Deal? Microsoft Buys Skype For $8.5 Billion In Cash

"...only time will tell if it will become indeed a significant threat, or a giant dud." - Techcrunch

So what's that $ 8.5 billion going to buy Microsoft? As an investor that's not easy to gauge.

Count me as skeptical.

I don't doubt Microsoft could make this into something uniquely valuable by integrating Skype with other Microsoft assets over time. It's a potential boost to their offerings in enterprise collaboration and the competitiveness of Windows Mobile among other things.

Here's one take on how it may make sense for Microsoft.

Why Microsoft is buying Skype for $ 8.5 billion

To some extent, I get the story behind this deal and my guess is it may even work out strategically (a.k.a. excuse to use too much shareholder money to buy an asset) yet likely still not enhance shareholder returns. Owners can't spend stories and strategic wins. In other words, management domain may end up enhanced here while owners pockets...not so much.

So, even if the rational is fine, it's not clear what it means in the long run economically. It's one of the reasons I don't like investing in tech companies unless the valuation is extremely low. For now, the question that cannot be answered is: Do they know what they are doing or just finding clever ways to burn up too much of the owners cash?

Most likely a bit of both.

Either way, if this makes so much sense for Microsoft why not buy Skype when eBay was under pressure to unload it at a much lower price less than two years back?

So the move may, in fact, turn out to make sense but they certainly paid more than they had to if they had just a bit more foresight.

I'm guessing that being behind the curve on so many fronts they felt that for competitive reasons this was a move that had to be done.

At the current valuation, I'd still expect a solid return from Microsoft's stock over five years despite the 1) odd tendency to misallocate capital and 2) real threats from Apple/Google/other competitors. As a company, Microsoft's overall story may or may not be a beauty but for an investor the long-term arithmetic still works at current valuations.

The bottom line is that, at the margin, the high price paid for this specific deal likely destroys some shareholder value even if it eventually works out okay otherwise in the long run. Fortunately, Microsoft's size makes the damage done to shareholders relatively small.

So far that is. It will soon become wise for investors to move on if a few more of these expensive "strategic" acquisitions is in the works.

You pay less for a company with management that routinely overpays on acquisitions.

Speaking of cash, the owners of Microsoft had plenty of it at nearly $ 50 billion on the balance sheet ($ 50 billion of cash - $12 billion of debt = $ 38 billion net cash).

I say had, of course, because now there is $ 8.5 billion less of it (to be fair they are still rather cash rich but a few more moves like this and it's real money even to Microsoft). If Skype is producing anything near $ 1 billion in free cash flow several years down the road or boosts Windows Mobile in a material way then the risks taken with this deal will end up making some sense. If not, Microsoft had (and has) the chance to buy a perfectly inexpensive stock at or near an ~8x multiple with that cash. Far more certainty in that.

The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value...The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended. - Warren Buffett in the 1984 Berkshire Hathaway Shareholder Letter

The fact is we may or may not ever know if this made financial sense for shareholders as Skype's future financial performance could easily be buried within a company Microsoft's size.

One of the concerns with all the cash that tech companies hold on their balance sheets is that it will be wasted.

This move by Microsoft should probably reaffirm that concern.

With nearly $ 6.8 billion of cash on the balance sheet at the end of the most recent quarter, eBay wasn't exactly cash poor before this transaction:

$ 6.8 billion cash, cash equivalents, and short-term investments
- $ 1.8 billion debt
= $ 5.0 billion net cash**

Once the deal is done with Microsoft they'll have $ 2.6 billion more.

Maybe the cash eBay receives from this transaction will be invested in something with a more clear cut return for shareholders.

Adam

Long positions in both MSFT and EBAY

* Plus a note from the buyer in the principal amount of $125 million
** eBay also had $ 2.7 billion in long-term investments at the end of 1Q
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Buffett on Coca-Cola, See's, Railroads, & Utilities: Berkshire Shareholder Letter Highlights

"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us." - Warren Buffett in the 2007 Berkshire Hathaway (BRKa) Shareholder Letter

Warren Buffett explains why a business like Coca-Cola (KO) or See's can offer effective protection against inflation in these excellent 2011 Berkshire meeting notes (by Ben Claremon).

Buffett also says that, while their capital intensive railroad and utility businesses should produce good returns over time, Coca-Cola and See's are the better businesses.

From the notes:

Question 8: Crowd - Aside from not needing to put huge amounts of capital to work, are Coke and See's still great business to own in an inflationary situation? Are they better than companies with irreplaceable hard assets and pricing power (like the railroad) in protecting against inflation?

Buffett: The first businesses are superior. If you have a great consumer product that requires very little capital to grow and support that growth--and you do more volume as inflation grows — that is a wonderful asset to protect against inflation. The ultimate example of that is your own earning ability. People who have made investments in themselves — outstanding teachers and doctors — see their wages increase with inflation. They also don't have to make an additional investment in themselves. People should think about a long term real estate asset like a farm where additional capital is not required to finance inflationary growth.

The worst businesses are the ones with huge receivables and inventories. Their volume stays flat and they have to come up with more money to finance that volume. Normally BRK does not like businesses that require a lot of capital — railroads and utilities. But, he and Charlie believe that they should be able to generate a good return in the railroad because of the value it provides to the economy. The ideal business is one like See's. See's Candy was doing $25M-$30M in revenue when they bought it and they were selling 16M* pounds of candy. Now they are doing over $300M in revenue. It took $9M of capital then and the business only needs $40M in tangible capital now. If the price of candy doubles they don't have any receivables or inventory. Fixed assets don't have to increase either.

It may not be obvious why a slow growth business like See's produces terrific returns. Just about everyday on business news and analyst reports you'll see, more often than not, the focus on future growth prospects.

Makes sense intuitively, right?

Not necessarily. That focus on growth is often misplaced.

The growth focus would make sense in a world where durable competitive advantage, pricing power, and the minimal need for incremental capital could be taken for granted in a business. For most businesses, that world doesn't exist.

Many businesses have grown much faster than See's for decades but end up lacking in some of the above qualities (or all the above qualities in the case of airlines) so investor returns ended up sub-par.

See's volumes have grown barely 2% per year since Berkshire bought it back in 1972 yet returns have been fantastic.

So if See's can achieve great returns with modest growth then the business with even higher growth and See's great characteristics must be even better, right?

In theory, if you can find a business like that...yes. In theory.

While there may be rare exceptions, in the real world, a business with See's-like economics that happens to also be growing very fast will eventually attract more competition. Having a well-executed first mover advantage matters but it's intense competition (there are some very good businesses that provoke little competition, in part, because of unexciting or modest growth characteristics) that might make what look like great economics today into not so great economics down the road.

So yes there are exceptions but they reside within the more unpredictable competitive environments (a place where more mistakes are likely to be made).

In both the 2007 Berkshire Hathaway shareholder letter and 1983 Berkshire Hathaway shareholder letter, Buffett provides an explanation of the characteristics that make See's a superior business.

For convenience, here are some previous posts (and excerpts) on See's that cover this ground.

From the 2007 Berkshire letter:

Buffett on "The Prototype Of A Dream Business"

"Let's look at the prototype of a dream business, our own See's Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn't grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See's, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.

At See's, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See's sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire."

Later Buffett continues....

"Last year See's sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us. (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.)"

From the 1983 Berkshire letter:

Buffett on Economic Goodwill

"...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."

I think See's is one of the more useful business case studies because it reveals that a business with: 1) durable competitive advantage, pricing power, and the minimal need for capital trumps growth, and 2) while the value of economic goodwill will not be found on a balance sheet it is extremely important and very real.

See's is a superior business because it is durable and, despite little in the way of growth prospects, it produces a high return on capital for the investor. The source of that high return on capital is its unique combination of qualities (durable competitive advantages, pricing power, modest needs incremental capital etc.).

Other businesses may not necessarily be the equal of See's but possess many of these same qualities (A hint: look in the cupboard).

See's as a case study seems simple and in many ways it is. I'm guessing the deceptive simplicity may make some say to themselves:

"There's got to be more to it than this."

Well, there really isn't.

The ideas just need to be internalized and applied with discipline. The bottom line: understanding See's more fully makes sense because the lessons from it are potentially lucrative for long-term investors.

Adam

Long BRKb and KO

Related previous posts:
Buffett on "The Prototype Of A Dream Business"
Buffett on Economic Goodwill

* The notes had 60M pounds as the number but the actual is 16M. More than understandable when typing that fast with no recording device. All in all, these are the best Berkshire notes I've seen.
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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.

Google Ranks Highest in Corporate Reputation Survey

From the latest Harris Interactive Survey on the reputations of the 60 most visible companies in the U.S.:

After falling to unforeseen lows amidst scandals, recalls and self-inflicted demonization economic crises, the American public's positive perception of the reputation of corporate America is on the rise.

Press Release: Google Ranks Highest on Corporate Reputation in 12th Annual Harris Interactive U.S. Reputation Quotient® (RQ®) Survey

The top five companies on this year's list:
1) Google (GOOG)

2) Johnson & Johnson (JNJ)

3) 3M Company (MMM)

4) Berkshire Hathaway (BRKa)

5) Apple (AAPL)

As a sector, technology companies are perceived the most favorably. The fact that Apple was not ranked even higher seems a surprise.

Five of the bottom ten in the rankings are large financial services firms.

52) J.P. Morgan (JPM)
55) Bank of America (BAC)
57) Citigroup (C)
58) Goldman Sachs (GS)
60) AIG (AIG)

So the leaders at some of the largest financial institutions have work to do whether they think the reputation is deserved or not. The fact that financial services firms "dominate" the bottom of the rankings makes sense after a partly self-inflicted near systemic meltdown.  

Still, in the long run a banking system perceived this way isn't good for anyone. At a minimum we're going to always need trusted, utility-like banking.

With assistance from behavior at some of the larger financial firms in recent years, Comcast (CMCSA) is not ranked among the bottom ten in reputation.

They're in the bottom eleven.

Well played, Comcast.

More from the press release:

There are six reputational dimensions that the RQ survey focuses on that influence reputation and consumer behavior.

Those dimensions are as follows:

-Social Responsibility
-Emotional Appeal 
-Financial Performance 
-Products & Services
-Vision & Leadership
-Workplace Environment 

Facebook enters the list for the first time ranked 31st.

The full survey can be found here.

Adam

Long positions in GOOG, JNJ, BRKb, AAPL, JPM, BAC, and C
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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.

Yacktman on "Old Tech"

The Yacktman Funds just released their 1Q 2011 Letter.

The fund managers at Yacktman are worth highlighting for their very solid long-term track record with equity investments combined with low turnover in the portfolio.

Some portfolio managers are in and out of stocks so quickly that it is difficult to gain much meaning from what they own at the end of each quarter.

One of the nice things about modest turnover, beyond the obvious benefit of lower frictional costs, is that the primary driver of Yacktman's long-term results is the ownership of great businesses, bought at fair prices, held for a long time.

Outperformance comes from the underlying economics of the businesses and the prices paid relative to those fundamentals instead of some unusual ability to trade in and out of securities at just the right time.

Based upon the most recent letter, the two Yacktman portfolios continue to be dominated by consumer staples, media, and healthcare.

A key theme highlighted in the letter is what they refer to as "old tech":

Microsoft (MSFT)

Hewlett Packard (HPQ)

Cisco (CSCO)

Intel (INTC)

Last quarter, Microsoft, HP, and Cisco all declined. In the last 12 months, Microsoft, HP, and Cisco are all down even though the S&P 500 is up more than 15%. We used the declines in these stocks to increase our weighting to this group of companies and add a small position in Intel in The Yacktman Fund only. We refer to this group of four companies as "old tech".

Investing is largely about what you buy and what you pay for it. Today, with the "old tech" positions in the funds, we think we are getting good businesses at fire sale prices. A little more than a decade ago, these same stocks were overvalued, causing the returns for many previous shareholders to be poor even though the businesses produced strong results.

Today, this "old tech" group is now so disliked it sells at less than ½ the multiple of the S&P 500 even though the companies in this group exhibit business characteristics that we believe are superior to the average company in the S&P 500. The "old tech" balance sheets are some of the strongest around.

More recently, since 2007, the underlying businesses of our "old tech" basket have performed well and vastly outperformed the S&P 500, yet the stocks have dramatically underperformed. Each of the four companies in our “old tech” basket sells at less than 10 times our projection of 2011 earnings, net of the cash on the balance sheet. As long as the businesses on average do not go into unpredicted, sudden, and rapid decline, our investments should do well over time.

Maybe the fact that they are thought of as "old tech" explains part of the valuation disconnect as the name alone implies decline. Of course, in the long run what matters is underlying business performance. So while ugly headlines and poor stock price performance reinforce the "old tech" image the underlying business performance in recent years has actually been more than solid.

If their underlying businesses continue to perform reasonably well, sooner or later, the voting that goes on in the short run will be superseded by the weight of underlying economics.

In any case, nothing spectacular is needed as far as business performance goes at these valuations.

Given the unpredictable competitive dynamics, I happen to think technology stocks should always be purchased with a larger than average margin of safety. Current valuations seem to offer just that. A margin of safety and then some for those familiar with the risks and opportunities in front of these businesses.

To me, some of these appear to be above average businesses selling at valuations implying some kind of imminent collapse or soon to be ruined economic moat.

It's worth noting that although Yacktman speaks favorably of "old tech", among technology only Microsoft is a top ten holding in the Yacktman Fund and Yacktman Focused Fund. So apparently they like these "old tech" stocks but not enough to give them the same kind of weighting as their favorite consumer staple, media, and healthcare holdings.

That weighting makes sense to me even at these seemingly reduced valuations.

Adam

Accumulating, or planning to accumulate, small long positions in the above stocks as they (hopefully) drop further in value.
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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.

Munger on the Financial Sector: "Whole System is Stark-Raving Mad"

On Monday, Charlie Munger spoke to Bloomberg Businessweek on his views of Wall Street's role in Europe's financial crisis. He describes how investment bankers helped mask Greece's troubles as "perfectly disgusting." From the article:

"Why should an investment banker go to Greece to teach them how to pretend their finances are different from what they really are? Why isn't that a perfectly disgusting bit of human behavior?"

In a separate interview with CNNMoney, Munger said that the financial sector should be downsized by about 80%. He doesn't see much benefit to the massive amount of trading between computers that goes on. He also doesn't seem to think the energy expended and talent utilized writing algorithms (that ultimately the rest of us pay for) provides much social contribution.

"...why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? No I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance?"

Charlie Munger: Get Rid of 80% of the Financial Sector

Munger also added the following:

"...short term trading is legalized front-running. It's just done electronically with code-breaking skills. I don't see any social contribution."

Basically, banking should more closely resemble the utility function that it has played in the past.

The Public-Utility Function

The Banking Power Utility

Michael Lewitt, president of Harch Capital Management, said in this Barron's article that the balance needs to be shifted back to favoring the public-utility function of the financial system.

What makes Munger's comments somewhat more interesting is the substantial investments in financial stocks that Berkshire Hathaway (BRKa) has at this point (Wells Fargo: WFC, U.S. Bancorp: USB, and Goldman Sachs warrants). So what Munger is saying cannot be described as beneficial to Berkshire Hathaway.

Charlie Munger later said this in the CNNMoney interview:

"...we invest in the world as it is. But if you ask me what the world should be, I would say that the finance sector of the world should be downsized by at least 80%."

...and when asked if it were downsized would they still invest in the banks they favor (Wells Fargo, U.S. Bancorp):

"Of course, it wouldn't affect us at all."

That 80% downsizing may seem like a stretch but consider that finance now makes up 8-9% of GDP. Up until the 1980s finance rarely occupied more than 4% of GDP and has fluctuated frequently around more like 3%. So some may say 80% is too much but let's just say an awful lot of downsizing would seem to make sense.

"What is Wall Street supposed to do? It's not a creator of wealth. It's a handmaiden to creators of wealth. It occupies an essentially parasitic, but usefully parasitic relationship with the rest of the society. It's totally out of control. It's not making America a great place; it's making America a worse place right now. That's the problem. Finance needs to occupy a healthier, more productive relationship with the rest of the society." - Michael Lewis, author of The Big Short, in this 2010 Bloomber Interview

I happen to think Wells Fargo and U.S. Bancorp, though not perfect by any means, come closer to the idea of performing the good old-fashioned utility function of banking. They're two of the better houses, with very good economics relative to peers, residing in a neighborhood with lots of excess.

Goldman Sachs, who may play the modern finance game as good as or better than their investment banking peers, still seem the ultimate symbol and example of the less than non-productive excesses that occurred and continue to this day.

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.