"...today inflation is nominal, treasuries are what 3.5%, corporate are 4 to 5, we're finding very good companies with free cash flow of 8% to 10%. So we're seeing better values than we've seen in a long time...we're seeing the Cadillacs are selling cheaper than the Chevys these days." - Ron Muhlenkamp
Check out the complete article.
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.
Friday, August 27, 2010
Thursday, August 26, 2010
Fighting the Last War
From this Fortune article:
...how could you have had three extended and anguishing periods of stagnation* that in aggregate--leaving aside dividends--would have lost you money? The answer lies in the mistake that investors repeatedly make...People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them.
The first part of the century offers a vivid illustration of that myopia. In the century's first 20 years, stocks normally yielded more than high-grade bonds. That relationship now seems quaint, but it was then almost axiomatic. Stocks were known to be riskier, so why buy them unless you were paid a premium? - Warren Buffett
...how could you have had three extended and anguishing periods of stagnation* that in aggregate--leaving aside dividends--would have lost you money? The answer lies in the mistake that investors repeatedly make...People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them.
The first part of the century offers a vivid illustration of that myopia. In the century's first 20 years, stocks normally yielded more than high-grade bonds. That relationship now seems quaint, but it was then almost axiomatic. Stocks were known to be riskier, so why buy them unless you were paid a premium? - Warren Buffett
What has occurred most recently informs behavior. The last decade has been terrible for stocks so investors decide to own less just when some of them finally start to become attractively valued. Check out the entire Fortune article.
Adam
* In 1899-1920 the Dow started at 66 and ended the period at 72. In 1929-1948 the Dow started at 381 and ended up at 177. Finally, in 1964-1981 it went from 874 to 875. In each case, the extended periods of stagnation for stocks were followed by market booms of 400% or more.
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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.
Adam
* In 1899-1920 the Dow started at 66 and ended the period at 72. In 1929-1948 the Dow started at 381 and ended up at 177. Finally, in 1964-1981 it went from 874 to 875. In each case, the extended periods of stagnation for stocks were followed by market booms of 400% or more.
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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.
Peter Lynch
Often, there is no correlation between the success of a company's operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies. - Peter Lynch
Nassim Taleb: "We Made $ 20 Billion For Our Clients"
Earlier this year, Nassim Taleb said there isn't enough evidence to show Buffett's five decades of investing success isn't just luck.
He also said that it made sense for "every single human being" to short Treasuries.
Great stuff.
Well, here's a quote by Taleb from this 2009 GQ article:
"I went for the jugular--we went for the max. I was interested in screwing these people--I'm not interested in money, but I wanted to teach them a lesson, and the only way you can do it is by trying to take it away from them. We didn't short the banks--there's not much to be gained there, these were all these complex instruments, options and so forth. We'd been building our positions for a while...when they went to the wall we made $20bn for our clients, half a billion for the Black Swan fund."
So, according to GQ, Taleb said "we made $ 20bn for our clients" but Janet Tavakoli checked into these claims and discovered otherwise:
"I checked with Nassim Taleb regarding the $20 billion in gains and asked if he were misquoted. He responded via email: 'The quote is inaccurate. THe [sic] 20 billion might correspond to the face value of positions.' This response is both vague and different in character from the mythical $20 billion in gains inaccurately quoted in GQ's article. The total gains could be a tiny fraction of what Taleb loosely describes as 'face value.'"
FT Alphaville offered the following view:
Tavakoli takes down GQ, not Taleb
"...it seems pretty clear from Tavakoli's letter that she is blaming GQ — not Taleb."
A separate article on FT Alphaville added that Taleb did point out the error to GQ beforehand:
"For whatever reason, it seems Self [the author of the GQ article] or GQ did not correct the story — perhaps because they stood by Taleb's quote.
In any case, if Taleb knew the number was incorrect he probably should have put up a note of some sort to accompany the article long before Tavakoli pointed it [sic] out the discrepancy."
Apparently, Taleb did try to correct the numbers well before the GQ article was published.
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.
He also said that it made sense for "every single human being" to short Treasuries.
Great stuff.
Well, here's a quote by Taleb from this 2009 GQ article:
"I went for the jugular--we went for the max. I was interested in screwing these people--I'm not interested in money, but I wanted to teach them a lesson, and the only way you can do it is by trying to take it away from them. We didn't short the banks--there's not much to be gained there, these were all these complex instruments, options and so forth. We'd been building our positions for a while...when they went to the wall we made $20bn for our clients, half a billion for the Black Swan fund."
So, according to GQ, Taleb said "we made $ 20bn for our clients" but Janet Tavakoli checked into these claims and discovered otherwise:
"I checked with Nassim Taleb regarding the $20 billion in gains and asked if he were misquoted. He responded via email: 'The quote is inaccurate. THe [sic] 20 billion might correspond to the face value of positions.' This response is both vague and different in character from the mythical $20 billion in gains inaccurately quoted in GQ's article. The total gains could be a tiny fraction of what Taleb loosely describes as 'face value.'"
FT Alphaville offered the following view:
Tavakoli takes down GQ, not Taleb
"...it seems pretty clear from Tavakoli's letter that she is blaming GQ — not Taleb."
A separate article on FT Alphaville added that Taleb did point out the error to GQ beforehand:
"For whatever reason, it seems Self [the author of the GQ article] or GQ did not correct the story — perhaps because they stood by Taleb's quote.
In any case, if Taleb knew the number was incorrect he probably should have put up a note of some sort to accompany the article long before Tavakoli pointed it [sic] out the discrepancy."
Apparently, Taleb did try to correct the numbers well before the GQ article was published.
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.
Wednesday, August 25, 2010
The "Drive By" Market
From this Bespoke Investment Group article on what it calls a "drive by" market:
"...from 1990 through 2006 the number of days where a net of 400 (80%) stocks in the S&P 500 moved in the same direction never exceeded 20 and averaged five per year."
According to Bespoke, the number has grown an awful lot since 2006 is on pace for at least 50 this year.
There's a good chart in the Bespoke article worth checking out that pretty much says it all. Later in the post they point to leveraged ETFs as one possible culprit in the exaggerated moves. I'm guessing it's somewhat more complicated than that but probably at least one good example among many of what's behind it.
To me, this kind of stuff is usually just background noise but there's no doubt all this financial "innovation" and the short term orientation that's evolved in the past couple decades sure has made a mess out of things. Lots of new participants owning stocks for weeks, days, or even seconds with no perspective beyond the end of their nose.
"...from 1990 through 2006 the number of days where a net of 400 (80%) stocks in the S&P 500 moved in the same direction never exceeded 20 and averaged five per year."
According to Bespoke, the number has grown an awful lot since 2006 is on pace for at least 50 this year.
There's a good chart in the Bespoke article worth checking out that pretty much says it all. Later in the post they point to leveraged ETFs as one possible culprit in the exaggerated moves. I'm guessing it's somewhat more complicated than that but probably at least one good example among many of what's behind it.
If buying stocks for the long-term best to ignore these daily gyrations other than using them to grab more shares whenever the market goes into a "drive by" funk.
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.
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.
Tuesday, August 24, 2010
10% FCF Yield
From an interview with Glenn Greenberg this past spring:
If you could buy a decent - not great, but decent quality business with a 10% free cash flow yield – my experience is that you would rarely lose money. A decent business is going to grow –maybe not really fast, but if you can start out with a 10% free cash flow yield and it is going to grow at some modest rate, 3-4%, you are going to end up with a pretty decent investment – a theoretical 13-14% rate of return.
Think about how that compares with what anyone says the market can offer over a given period of time, which is between 7-8%. So the question is why should a decent quality or good quality business be priced to give you a 13-15% return when the market is priced to give you a return of about half that?
If you could buy a decent - not great, but decent quality business with a 10% free cash flow yield – my experience is that you would rarely lose money. A decent business is going to grow –maybe not really fast, but if you can start out with a 10% free cash flow yield and it is going to grow at some modest rate, 3-4%, you are going to end up with a pretty decent investment – a theoretical 13-14% rate of return.
Think about how that compares with what anyone says the market can offer over a given period of time, which is between 7-8%. So the question is why should a decent quality or good quality business be priced to give you a 13-15% return when the market is priced to give you a return of about half that?
What Greenberg says about "decent" businesses also applies to the better franchises. You may not be able to pick the great ones up at a 10% FCF yield but their superior and durable economics will produce better than market returns at lower risk.
You can't compare returns between investments without adjusting for the risks taken to achieve those returns.
The lower risk profile matters.
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.
Monday, August 23, 2010
Buffett on the Stock Market
I think the following makes the truly excessive focus on the next economic indicator by business media, analysts, and others look kinda silly.
It's well established that Buffett does not believe attempting to time or predict the market is wise or even possible. Yet, in the past, he has been willing to articulate what he believes are the economic and psychological forces that determine stock prices. Here's one example. In 2001 he had this to say in Fortune about the stock market.
Things like growth in GDP reveal little about the future of the stock market though the daily obsession with the latest economic indicator may make some feel otherwise. Better to have some skepticism the next time anyone implies a strong correlation. Most macro factors mean very little in the context of successful long-term equity investing.
The last time I tackled this subject, in 1999, I broke down the previous 34 years into two 17-year periods*, which in the sense of lean years and fat were astonishingly symmetrical. Here's the first period. As you can see, over 17 years the Dow gained exactly one-tenth of one percent.
Dow Jones Industrial Average
Dec. 31, 1964: 874.12
Dec. 31, 1981: 875.00
And here's the second, marked by an incredible bull market that, as I laid out my thoughts, was about to end (though I didn't know that).
Dow Jones Industrial Average
Dec. 31, 1981: 875.00
Dec. 31, 1998: 9181.43
Now, you couldn't explain this remarkable divergence in markets by, say, differences in the growth of gross national product. In the first period--that dismal time for the market--GNP actually grew more than twice as fast as it did in the second period.
Gain in Gross National Product
1964-1981: 373%
1981-1998: 177%
So what was the explanation? I concluded that the market's contrasting moves were caused by extraordinary changes in two critical economic variables--and by a related psychological force that eventually came into play.
Here I need to remind you about the definition of "investing," which though simple is often forgotten. Investing is laying out money today to receive more money tomorrow.
That gets to the first of the economic variables that affected stock prices in the two periods--interest rates. In economics, interest rates act as gravity behaves in the physical world. At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset. You see that clearly with the fluctuating prices of bonds. But the rule applies as well to farmland, oil reserves, stocks, and every other financial asset. And the effects can be huge on values. If interest rates are, say, 13%, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%.
So here's the record on interest rates at key dates in our 34-year span. They moved dramatically up--that was bad for investors--in the first half of that period and dramatically down--a boon for investors--in the second half.
Interest rates, Long-term government bonds
Dec. 31, 1964: 4.20%
Dec. 31, 1981: 13.65%
Dec. 31, 1998: 5.09%
The other critical variable here is how many dollars investors expected to get from the companies in which they invested. During the first period expectations fell significantly because corporate profits weren't looking good. By the early 1980s Fed Chairman Paul Volcker's economic sledgehammer had, in fact, driven corporate profitability to a level that people hadn't seen since the 1930s.
The upshot is that investors lost their confidence in the American economy: They were looking at a future they believed would be plagued by two negatives. First, they didn't see much good coming in the way of corporate profits. Second, the sky-high interest rates prevailing caused them to discount those meager profits further. These two factors, working together, caused stagnation in the stock market from 1964 to 1981, even though those years featured huge improvements in GNP. The business of the country grew while investors' valuation of that business shrank!
And then the reversal of those factors created a period during which much lower GNP gains were accompanied by a bonanza for the market. First, you got a major increase in the rate of profitability. Second, you got an enormous drop in interest rates, which made a dollar of future profit that much more valuable. Both phenomena were real and powerful fuels for a major bull market. And in time the psychological factor I mentioned was added to the equation: Speculative trading exploded, simply because of the market action that people had seen.
Dow Jones Industrial Average
Dec. 31, 1964: 874.12
Dec. 31, 1981: 875.00
And here's the second, marked by an incredible bull market that, as I laid out my thoughts, was about to end (though I didn't know that).
Dow Jones Industrial Average
Dec. 31, 1981: 875.00
Dec. 31, 1998: 9181.43
Now, you couldn't explain this remarkable divergence in markets by, say, differences in the growth of gross national product. In the first period--that dismal time for the market--GNP actually grew more than twice as fast as it did in the second period.
Gain in Gross National Product
1964-1981: 373%
1981-1998: 177%
So what was the explanation? I concluded that the market's contrasting moves were caused by extraordinary changes in two critical economic variables--and by a related psychological force that eventually came into play.
Here I need to remind you about the definition of "investing," which though simple is often forgotten. Investing is laying out money today to receive more money tomorrow.
That gets to the first of the economic variables that affected stock prices in the two periods--interest rates. In economics, interest rates act as gravity behaves in the physical world. At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset. You see that clearly with the fluctuating prices of bonds. But the rule applies as well to farmland, oil reserves, stocks, and every other financial asset. And the effects can be huge on values. If interest rates are, say, 13%, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%.
So here's the record on interest rates at key dates in our 34-year span. They moved dramatically up--that was bad for investors--in the first half of that period and dramatically down--a boon for investors--in the second half.
Interest rates, Long-term government bonds
Dec. 31, 1964: 4.20%
Dec. 31, 1981: 13.65%
Dec. 31, 1998: 5.09%
The other critical variable here is how many dollars investors expected to get from the companies in which they invested. During the first period expectations fell significantly because corporate profits weren't looking good. By the early 1980s Fed Chairman Paul Volcker's economic sledgehammer had, in fact, driven corporate profitability to a level that people hadn't seen since the 1930s.
The upshot is that investors lost their confidence in the American economy: They were looking at a future they believed would be plagued by two negatives. First, they didn't see much good coming in the way of corporate profits. Second, the sky-high interest rates prevailing caused them to discount those meager profits further. These two factors, working together, caused stagnation in the stock market from 1964 to 1981, even though those years featured huge improvements in GNP. The business of the country grew while investors' valuation of that business shrank!
And then the reversal of those factors created a period during which much lower GNP gains were accompanied by a bonanza for the market. First, you got a major increase in the rate of profitability. Second, you got an enormous drop in interest rates, which made a dollar of future profit that much more valuable. Both phenomena were real and powerful fuels for a major bull market. And in time the psychological factor I mentioned was added to the equation: Speculative trading exploded, simply because of the market action that people had seen.
Things like growth in GDP reveal little about the future of the stock market though the daily obsession with the latest economic indicator may make some feel otherwise. Better to have some skepticism the next time anyone implies a strong correlation. Most macro factors mean very little in the context of successful long-term equity investing.
The initial price of a stock relative to its intrinsic value, growth in that value driven by profitability, future interest rates, and psychological factors are what determine future prices. Being able to see upfront the mispricing of an individual securities (usually when the micro and macro news is bad) and avoiding the mistake of projecting forward recent economic and investing experience make a huge difference.
Experience cannot be informed by a short historical perspective.
In 1999 many were projecting forward, incorrectly, the experience of the 1980s and 1990s bull markets into the 2000s. Any recent experience in the collective psyche of investors can help cause mispricing of individual securities. Knowing history is smart but it needs to cover a sufficiently long time frame.
Otherwise, what's recently been in the rear-view mirror distorts expected future outcomes.
Adam
* Art Cashin makes reference to the 17.6 Year Market Cycle in this previous post.
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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.
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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.
High-Speed Trading & Quality Large Caps
In this Barron's interview, Morris Mark makes the following notable points:
- High-speed traders pull out about $ 20 billion/year from the system whereas their predecessors pulled more like $ 200 million. If true, that's a 100-fold increase in frictional costs. So there is now substantial additional frictional costs in the system that seems to benefit only the high-speed traders. The costs, naturally, are borne by other market participants.
- On a more positive not, he says quality large caps can be bought at no premium and added that Google, IBM, and Coca-Cola are examples.
- Coca-Cola's pervasive brand and distribution system are crucial assets especially as the emerging middle class continues to grow.
The long-term economics of businesses like Coca-Cola tend to be very favorable. Businesses with brands and strong distribution are often capable of producing durable high return on capital over the long haul.
Unfortunately, high-speed trading won't be reigned in anytime soon. Check out the full interview.
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.
- High-speed traders pull out about $ 20 billion/year from the system whereas their predecessors pulled more like $ 200 million. If true, that's a 100-fold increase in frictional costs. So there is now substantial additional frictional costs in the system that seems to benefit only the high-speed traders. The costs, naturally, are borne by other market participants.
- On a more positive not, he says quality large caps can be bought at no premium and added that Google, IBM, and Coca-Cola are examples.
- Coca-Cola's pervasive brand and distribution system are crucial assets especially as the emerging middle class continues to grow.
The long-term economics of businesses like Coca-Cola tend to be very favorable. Businesses with brands and strong distribution are often capable of producing durable high return on capital over the long haul.
Unfortunately, high-speed trading won't be reigned in anytime soon. Check out the full interview.
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.
Thursday, August 19, 2010
Earnings Yield
From Michael Santoli's column in Barron's:
J.P. Morgan noted last week that the forward "earnings yield" of the Standard & Poor's 500 based on current forecasts is 8.1%, while high-yield bonds were at 8.3%—the narrowest spread in history (it has averaged 5.1% since 1987).
The above, of course, guarantees nothing in the short run but sets up reasonably well if your time horizon is measured in several years.
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.
J.P. Morgan noted last week that the forward "earnings yield" of the Standard & Poor's 500 based on current forecasts is 8.1%, while high-yield bonds were at 8.3%—the narrowest spread in history (it has averaged 5.1% since 1987).
The above, of course, guarantees nothing in the short run but sets up reasonably well if your time horizon is measured in several years.
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.
Creativity Crisis?
After rising for decades in America, the scores on a test that is the gold standard for measuring creativity have been falling.
Apparently, the test predicts future creative accomplishment incredible well.
Apparently, the test predicts future creative accomplishment incredible well.
The correlation to lifetime creative accomplishment was more than three times stronger for childhood creativity than childhood IQ.
Like intelligence tests, Torrance's test—a 90-minute series of discrete tasks, administered by a psychologist—has been taken by millions worldwide in 50 languages. Yet there is one crucial difference between IQ and CQ scores. With intelligence, there is a phenomenon called the Flynn effect—each generation, scores go up about 10 points. Enriched environments are making kids smarter. With creativity, a reverse trend has just been identified and is being reported for the first time here: American creativity scores are falling.
Creativity scores had been climbing until 1990 but since then have reversed the trend.
The article points out that it's too early to determine why U.S. creativity scores are declining but suggests some possible culprits.
- # of hours kids now spend in front of the TV/playing videogames
- Creativity development (or lack thereof) in our schools.
Seems a trend worth reversing. It can't be a good thing as far as economic progress over the long run is concerned.
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.
Wednesday, August 18, 2010
Buffett: Indebted to Academics
Warren Buffett wrote the following about the Washington Post in the 1985 Berkshire Hathaway (BRKa) shareholder letter:
Long BRKb
Related posts:
-Grantham on "The Greatest-Ever Failure of Economic Theory"
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind
We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise. Calculating the price/value ratio required no unusual insights. Most security analysts, media brokers, and media executives would have estimated WPC's intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market valuation was published daily for all to see. Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.
Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value - and even thought, itself - were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by yearend 1974 our WPC holding showed a loss of about 25%, with market value at $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents on the dollar of intrinsic value.
You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the exceptional economics of the business and the stock price moved closer to underlying value. Thus, we experienced a triple dip: the company's business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.
It can take quite a while for the gap between price & intrinsic value to be recognized by the market.
A good business selling under intrinsic value will often get even cheaper. The mispricing can continue for a long time, even years, but the benefits of that persistently low price should ultimately accrue to long-term shareholders (through the purchase of stock at bargain prices using excess cash generated over time).
Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value - and even thought, itself - were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by yearend 1974 our WPC holding showed a loss of about 25%, with market value at $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents on the dollar of intrinsic value.
You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the exceptional economics of the business and the stock price moved closer to underlying value. Thus, we experienced a triple dip: the company's business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.
It can take quite a while for the gap between price & intrinsic value to be recognized by the market.
A good business selling under intrinsic value will often get even cheaper. The mispricing can continue for a long time, even years, but the benefits of that persistently low price should ultimately accrue to long-term shareholders (through the purchase of stock at bargain prices using excess cash generated over time).
Adam
Long BRKb
Related posts:
-Grantham on "The Greatest-Ever Failure of Economic Theory"
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind
Related article:
-Warren Buffett And Washington Post
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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.
-Warren Buffett And Washington Post
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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.
Diageo's Liquid Assets Plug Pension Deficit
Diageo (DEO) fills a pension deficit by transferring 2.5 million barrels of aging whisky into its pension fund.
The whisky serves as collateral.
This Wall Street Journal article gives some more background on it.
Apparently, it is enough booze to fill 180 Olympic-size swimming pools or roughly 30% of Diageo's whisky stock.
For the companies with extremely large pension obligations this may yet become an even bigger headache (hangover?) not too far down the road.
Adam
Long DEO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
The whisky serves as collateral.
This Wall Street Journal article gives some more background on it.
Apparently, it is enough booze to fill 180 Olympic-size swimming pools or roughly 30% of Diageo's whisky stock.
For the companies with extremely large pension obligations this may yet become an even bigger headache (hangover?) not too far down the road.
Adam
Long DEO
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.
Tuesday, August 17, 2010
Berkshire Hathaway 2nd Quarter 2010 13F-HR
Berkshire Hathaway's (BRKa) 2nd Quarter 2010 13F-HR was released yesterday.
Currently, the equity portfolio is made up of 39.3% financials, 39.1% consumer goods, 7.3% consumer services, and 5.9% healthcare. The remainder is spread across miscellaneous industrials and energy. The top five holdings are:
Equities Sold
Buffett did not sell out of any positions entirely but made minor reductions in exposure to the following:
Currently, the equity portfolio is made up of 39.3% financials, 39.1% consumer goods, 7.3% consumer services, and 5.9% healthcare. The remainder is spread across miscellaneous industrials and energy. The top five holdings are:
- Coca-Cola (KO) = $ 11.2 billion (23.1% of the portfolio)
- Wells Fargo (WFC) = $ 8.2 billion (17.0%)
- American Express (AXP) = $ 6.3 billion (12.9%)
- Procter and Gamble (PG) = $ 4.7 billion (9.7%)
- Kraft (KFT) = $ 3.1 billion (6.4%)
The top 5 holdings remain the same as last quarter representing more than 2/3's of the ~$ 48 billion equity portfolio value*.
Here's a summary of changes made to the portfolio this past quarter.
Buffett did not sell out of any positions entirely but made minor reductions in exposure to the following:
- ConocoPhillips (COP) - Cut position by ~15%
- M&T Bank (MTB) - Cut by 3.6%
- Kraft (KFT) - Cut by 1.4%
- Procter & Gamble (PG) - Cut by 1.3%
Equities Purchased
The biggest purchase this quarter was by far Johnson and Johnson (JNJ). Approximately $ 1 billion of additional shares (a 2.2% impact on the portfolio) were purchased bringing the total value of the position to $ 2.4 billion. JNJ is now the 6th largest position. It appears Buffett is re-building the JNJ position after selling some of it off to make room for the Burlington Northern Santa Fe acquisition.
The biggest purchase this quarter was by far Johnson and Johnson (JNJ). Approximately $ 1 billion of additional shares (a 2.2% impact on the portfolio) were purchased bringing the total value of the position to $ 2.4 billion. JNJ is now the 6th largest position. It appears Buffett is re-building the JNJ position after selling some of it off to make room for the Burlington Northern Santa Fe acquisition.
FISERV (FISV) was the largest entirely new position (~$ 200 million...still pretty small in this context with only a .43% impact on portfolio).
Very small incremental increases were also made to the following:
None of these 4 purchases was more than .02% of the equity portfolio's value.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, KFT, COP, SNY, and JNJ.
None of these 4 purchases was more than .02% of the equity portfolio's value.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, KFT, COP, SNY, and JNJ.
* 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 (i.e. shares in BYD, POSCO, Sanofi, and Tesco).
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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.
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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.
Friday, August 13, 2010
Johnson & Johnson Debt at Record Low Rates
This Bloomberg article points out Johnson & Johnson (JNJ) sold over $ 1 billion of bonds at the lowest interest rates on record going back to 1981. These rates were on 10-year and 30-year debt.
10-year notes: 2.95 percent
30-year bonds: 4.5 percent
10-year notes: 2.95 percent
30-year bonds: 4.5 percent
Back in the early 1980s, there were 60 non-financial U.S. companies with triple-A ratings according to Standard and Poor's. Today, there are only 4: Johnson & Johnson, Automatic Data Processing (ADP), Exxon (XOM), and Microsoft (MSFT). Many of the best franchises produce enough capital on their own to expand so the impact it will have on their cost of capital is limited.
Still, if rates continue to stay low some companies with less than triple-A ratings have the potential to build a foundation of lower cost capital. The foundation will be built over time as they roll over or take on new debt. Ultimately, it has the potential to provide some extra fuel to equity investor returns in the coming years.
Adam
Long JNJ, ADP, and MSFT
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Long JNJ, ADP, and MSFT
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, August 12, 2010
Tuning Out the Consensus
It's difficult to not be influenced by consensus opinion. This Wall Street Journal article explains some fundamental reasons why it's not easy to be contrarian based upon a study in the journal Current Biology,
What did the study find?
Well, according to the study it turns out...
...the value you place on something is likely to go up when other people tell you it is worth more than you thought, and down when others say it is worth less. More strikingly, if your evaluation agrees with what others tell you, then a part of your brain that specializes in processing rewards kicks into high gear.What did the study find?
Well, according to the study it turns out...
In other words, investors often go along with the crowd because—at the most basic biological level—conformity feels good. Moving in herds doesn't just give investors a sense of "safety in numbers." It also gives them pleasure.
Apparently, scans revealed that one of the brain's reward centers (a region called the ventral striatum) basically lit up when participants learned that they had chosen the same song as the experts. The ventral striatum is a region wired with dopamine neurons.
Also, that others agree with your choice is rewarding in the same way food or money is and the forces at work can travel quickly through a population.
Buy what you understand, especially when it's unpopular, and learn to mostly ignore what others are doing.
Adam
HT: Gaurang Sathaye
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.
Wednesday, August 11, 2010
Michael Porter: U.S. Needs Increased Domestic Investment
Recently, Harvard Business School Professor Michael Porter was on CNBC's The Kudlow Report.
Video: Porter on CNBC
In the segment with Larry Kudlow he makes the following points:
In the segment with Larry Kudlow he makes the following points:
- There is too much uncertainty right now so businesses are just trying to run themselves lean vs expansion and hiring. Much of the uncertainty is government related.
- Need to change the atmosphere. A war is going on between government and businesses and is really distressing from his point of view. Business feels attacked. Change of tone is needed or some new players in the adminstration who can change that tone.
- He advises companies to drive productivity and improve technology. Today, for the most part that is what business is doing by investing in software and capital equipment.
- US foreign investment is happening. The problem is lack of US domestic investment.
- Data shows that US domestic investment as % of GDP is actually lowest among OECD countries.
- Our individual companies are competitive globally but they hold back investment in the US because the cost and complexity (healthcare, litigation, taxes, other regulations etc.) of doing business in the states has piled up over the years. Each rule and regulation probably began with good intentions.
- In the Global Competitiveness Report, the US now ranks like a developing country in terms of cost and complexity of doing business.
- Health care costs highest in world.
- Business is spooked by the union proposals that are being made.
- Human resource pool is sometimes found lacking for certain skill sets and, in some cases, those skill sets have a comparatively high cost. Companies move investment globally wherever they can be most productive.
Having the lowest domestic investment as a % of GDP among OECD countries certainly needs to change.
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.
Tuesday, August 10, 2010
Buffett: Net Buyer of Equities in 2Q 2010
From looking at Berkshire Hathaway's (BRKa) last two quarterly cash flow statements, it's clear Buffett was buying significantly more equities in the 2nd quarter than he was selling.
The cash flow statement in the most recent 10-Q, specifically the 2nd quarter cash flows from investing activities section, shows that Buffett bought $ 3.282 billion in equities and sold $ 2.710 billion in equities ytd. That's no big deal in itself but the 2nd quarter 10-Q only gives a ytd look at cash flows. So you need to look at the 1st quarter cash flows from investing activities and subtract the difference. If you subtract the equities bought & sold in the 1st quarter from the 2nd quarter, you get a clean look at the equities bought in 2Q alone. Doing this simple math reveals:
Equities Bought: 1.638 billion
Equities Sold: .427 billion
Net Buying: 1.211 billion
We should find out when the 13F-HR is released the specific equities he was buying and selling. A couple reasons why we may not find out what he bought/sold is that: 1) the SEC allows Buffett to hold back from the 13F-HR what he is buying/selling under certain circumstances (building a large position), or 2) the equities bought/sold do not trade on a US exchange.
The latest 10-Q revealed a minor further drop in the cost basis of Procter & Gamble (PG), so that was some of the selling in the 2nd quarter.
Adam
Long BRKb and PG
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Long BRKb and PG
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, August 9, 2010
Quality Stocks: Ping Pong Balls Under Water
From Jeremy Grantham's essay The Fearful, Speculative Market:
Supply-demand issues...can be powerful in distorting prices in the short run and even the quite long run, but it is like holding a ping pong ball under water: it needs constant pressure to keep it there. Remove the pressure even for a short while and the normal equilibrium will quickly be restored.
The core economics win out in the long run.
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.
Supply-demand issues...can be powerful in distorting prices in the short run and even the quite long run, but it is like holding a ping pong ball under water: it needs constant pressure to keep it there. Remove the pressure even for a short while and the normal equilibrium will quickly be restored.
The core economics win out in the long run.
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.
Berkshire Hathaway's 2Q Results
Berkshire Hathaway released the most recent quarterly results this past Friday. In the release, Buffett expressed some optimism about the US economy and said operating results for its manufacturing, service and retail businesses had improved. Here's a post commenting on the 2Q results.
Excerpt:
We have previously highlighted the dangers of focusing exclusively on the "headline numbers" regarding Berkshire Hathaway and cynics may believe that we are viewing the world (or at least Berkshire) through rose colored glasses. However, the reality is that Berkshire’s large portfolio of derivatives cause very wide fluctuations in net income each quarter because they are marked to market and the result flows through the income statement. To argue that ignoring such movements in the short run is warranted is tantamount to making the same argument regarding broad moves in the equity market, and self evident to most value investors.
Unfortunately, for many market participants, short term is a few hours or overnight, long term is holding a position over a weekend, and a quarter is an eternity. For such observers, all that matters is the loud headline stating that Berkshire’s net income dropped by 40 percent for the quarter. Unfortunately, such myopia would conceal the underlying trends evident in the business.
The article includes this chart on Berkshire Hathaway's Manufacturing, Retail, and Service business pre-tax quarterly earnings since 1Q08:
You can see from the chart that most of Buffett's operating businesses are reasonably cyclical in nature.
On Berkshire Hathaway's Derivatives
The derivatives portfolio can make interpreting Berkshire Hathaway's results confusing. I'm sure after all of Buffett's criticism of derivatives over the past decade it probably seems strange to some that this would be the case. No doubt Berkshire's derivatives (managed by Buffett personally) add an annoying amount of noise to the short-run quarterly income statement, but that doesn't mean they don't make economic sense for Berkshire Hathaway shareholders in the long-run. The question is whether the risks of those derivatives are being well-managed. I think they are but will explore that open question in a follow up.
Adam
Excerpt:
We have previously highlighted the dangers of focusing exclusively on the "headline numbers" regarding Berkshire Hathaway and cynics may believe that we are viewing the world (or at least Berkshire) through rose colored glasses. However, the reality is that Berkshire’s large portfolio of derivatives cause very wide fluctuations in net income each quarter because they are marked to market and the result flows through the income statement. To argue that ignoring such movements in the short run is warranted is tantamount to making the same argument regarding broad moves in the equity market, and self evident to most value investors.
Unfortunately, for many market participants, short term is a few hours or overnight, long term is holding a position over a weekend, and a quarter is an eternity. For such observers, all that matters is the loud headline stating that Berkshire’s net income dropped by 40 percent for the quarter. Unfortunately, such myopia would conceal the underlying trends evident in the business.
The article includes this chart on Berkshire Hathaway's Manufacturing, Retail, and Service business pre-tax quarterly earnings since 1Q08:
You can see from the chart that most of Buffett's operating businesses are reasonably cyclical in nature.On Berkshire Hathaway's Derivatives
The derivatives portfolio can make interpreting Berkshire Hathaway's results confusing. I'm sure after all of Buffett's criticism of derivatives over the past decade it probably seems strange to some that this would be the case. No doubt Berkshire's derivatives (managed by Buffett personally) add an annoying amount of noise to the short-run quarterly income statement, but that doesn't mean they don't make economic sense for Berkshire Hathaway shareholders in the long-run. The question is whether the risks of those derivatives are being well-managed. I think they are but will explore that open question in a follow up.
Adam
Hansen's 2Q Results
Looks like an excellent quarter from Hansen Natural (HANS). Historically, Hansen's Monster Energy brand has been a domestic story, but the traction of their international business appears to have started to kick in.
The stock is now selling at more than 17x forward earnings (~15x if you back out the cash & short-term investments...currently ~$ 470 million).
The shares are up more than 50% since my first mention of Hansen on July 21st, 2009 in Stocks to Watch. Back then the stock was selling at more like 11x earnings and even less after backing out the net cash on the balance sheet.
Here's an article that discusses some of the 2Q results.
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.
The stock is now selling at more than 17x forward earnings (~15x if you back out the cash & short-term investments...currently ~$ 470 million).
The shares are up more than 50% since my first mention of Hansen on July 21st, 2009 in Stocks to Watch. Back then the stock was selling at more like 11x earnings and even less after backing out the net cash on the balance sheet.
Here's an article that discusses some of the 2Q results.
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.
Thursday, August 5, 2010
American Express and the Downgrade/Upgrade Cycle
When any good franchise goes through a period like the past three years, the intrinsic value does not necessarily change very much even though short-term earnings may be impaired. Back in April of 2009, when American Express (AXP) was selling at $ 15/share, I said that my best estimate of AXP's intrinsic value was between $ 55-65/share within 3 years. Beyond that time frame, like any great business I expected AXP to steadily increase its intrinsic value. Today, AXP is selling at ~$ 43/share so that price to intrinsic value gap has closed substantially*.
Still a great business but no longer a bargain.
While the financial crisis did delay some of AXP's increase in intrinsic value, its value did not move around nearly as much as the helter skelter stock prices or Wall Street analyst upgrades, downgrades, and new price targets would make you think. Just one example among many:
January 27th, 2009: Citi reiterates a 'Sell' rating on AmEx, lowers price target from $19 to $14. Link
March 12th, 2009: Citi maintains a 'Sell' rating on AmEx, lowers price target from $14 to $9. Link
April 7th, 2009: Citi upgrades AmEx from 'Sell' to 'Hold'. Increases price target from $9 to $16. Link
April 24th, 2009: Citi maintains a 'Hold' on AmEx, raises price target from $16 to $22. Link
August 6th, 2009: Citi upgrades AmEx from 'Hold' to 'Buy'. Price target to $36. Citi also added AmEx to its Top Picks Live list. Link
April 13th, 2010: Citi reiterates a 'Buy' on AmEx, price target raised from $48 to $51. Link
April 23rd, 2010: Citi maintains a 'Buy' on AmEx, raises price target from $51 to $55. Link
Let's see.
Sell the stock when at $ 15.56-16.83/share. That was the market price range on January 27th, 2009 when AXP was downgraded to 'sell' with a $ 14 price target.
Still a great business but no longer a bargain.
While the financial crisis did delay some of AXP's increase in intrinsic value, its value did not move around nearly as much as the helter skelter stock prices or Wall Street analyst upgrades, downgrades, and new price targets would make you think. Just one example among many:
January 27th, 2009: Citi reiterates a 'Sell' rating on AmEx, lowers price target from $19 to $14. Link
March 12th, 2009: Citi maintains a 'Sell' rating on AmEx, lowers price target from $14 to $9. Link
April 7th, 2009: Citi upgrades AmEx from 'Sell' to 'Hold'. Increases price target from $9 to $16. Link
April 24th, 2009: Citi maintains a 'Hold' on AmEx, raises price target from $16 to $22. Link
August 6th, 2009: Citi upgrades AmEx from 'Hold' to 'Buy'. Price target to $36. Citi also added AmEx to its Top Picks Live list. Link
April 13th, 2010: Citi reiterates a 'Buy' on AmEx, price target raised from $48 to $51. Link
April 23rd, 2010: Citi maintains a 'Buy' on AmEx, raises price target from $51 to $55. Link
Let's see.
Sell the stock when at $ 15.56-16.83/share. That was the market price range on January 27th, 2009 when AXP was downgraded to 'sell' with a $ 14 price target.
Sell the stock again when at $ 11.09-13.38/share. That was the market price range on March 12th, 2009 when AXP was downgraded to 'sell' with a $ 9 price target.
AXP was then upgraded to a 'hold' on two occasions with raised price targets in April 2009 (I guess this is for investors who ignored the recent 'sell' recommendations.)
In August 2009, when the shares were $ 30.92-32.24/share, AXP was upgraded to 'buy' with a price target of $ 36 (four times higher than the one set in March 2009). By the following April 13th of 2010, on a day AXP was selling in the $ 44.33-45.06/share range, it remained a 'buy' but the target was raised to $ 51.
Finally, with the stock selling at $ 47.66-49.19/share on April 23, 2010, AXP was still rated a 'buy' with a new $ 55 price target.
In a nutshell:
- Sell shares at roughly $ 15-16/share
- Sell more shares at roughly $ 11-13/share
- Hold what's not been sold
- Start buying again at many times higher prices
At the very least, seems just a little bit impractical. The 'sell' rating in January 2009 to the last 'buy' rating in April 2010 covered a time frame of roughly 15 months.
AXP was then upgraded to a 'hold' on two occasions with raised price targets in April 2009 (I guess this is for investors who ignored the recent 'sell' recommendations.)
In August 2009, when the shares were $ 30.92-32.24/share, AXP was upgraded to 'buy' with a price target of $ 36 (four times higher than the one set in March 2009). By the following April 13th of 2010, on a day AXP was selling in the $ 44.33-45.06/share range, it remained a 'buy' but the target was raised to $ 51.
Finally, with the stock selling at $ 47.66-49.19/share on April 23, 2010, AXP was still rated a 'buy' with a new $ 55 price target.
In a nutshell:
- Sell shares at roughly $ 15-16/share
- Sell more shares at roughly $ 11-13/share
- Hold what's not been sold
- Start buying again at many times higher prices
At the very least, seems just a little bit impractical. The 'sell' rating in January 2009 to the last 'buy' rating in April 2010 covered a time frame of roughly 15 months.
In that roughly 15 month stretch, somehow the value of one business went from ~ $ 22 billion (using the initial lowered from price target of $19/share on January 27th, 2009) down to a little over $ 10 billion (using the price target of $ 9/share on March 12th, 2009) then up to ~ $ 66 billion (using the price target of $ 55/share on April 23rd, 2010).**
Huh?
Sorry, but the intrinsic value of a business like American Express just does not change that much in such a short time frame.
Now, I realize these upgrades/downgrades are likely for market participants with a shorter time horizon but, practically speaking, it makes sense to step back a bit. A little less focus on potential near-term price action and more emphasis on long-term values goes a long way for those investing with a long time horizon in mind.
Trading is about price action. Investing is about what the underlying asset is going to produce over a long time frame.
When it comes to getting satisfactory or better LONG-TERM investing results, estimating what a business is intrinsically worth per share (and the rate that value is likely to increase over time) matters.
Buying shares at a nice discount to that conservative estimate of value also matters.
How the shares might temporarily trade in the near-term or even longer also matters but the reasons may be less intuitive.
(It's a good thing if a stock that's been bought below per share intrinsic value drops further since it allows for more shares to be accumulated cheap. Even for those shareholders who don't want to own more shares it's a good thing. A cheap stock allows each dollar spent on share repurchases to go further. The longer the cheap stock persists, the more it boosts long-term returns. Obviously, no one complains about a stock that rallies right after they buy it. Yet that's actually not the best outcome for those interested in long-term effects.)
To me, it is better to use energy judging whether an understandable business (understandable is, of course, necessarily very much down to individual investors strengths and limits) has durable, attractive economics and, if it does, what the shares are likely to be worth over the longer run. Hardly an easy thing to judge with any precision (more a range of values) but, with some work, occasionally doable.
In my view, investing is mostly about whether the price provides sufficient margin of safety and an attractive long-term return considering the specific risks (and in relation to investing alternatives).
Generally speaking, investing requires discipline, patience, and an even temperament. It's not just judging what something is intrinsically worth based upon what's quantifiable then buying shares at a discount. That's important but insufficient. A bunch of subjective and qualitative judgments have to also be made since much of what counts is not quantifiable.
Yet, none of this is exactly rocket science. With all of this in mind, I'm just saying that trying to guess the near term price action of a stock, then somehow successfully trading around it, seems like an extremely poor use of energy.
Adam
Long position in AXP
* AXP remains a core holding in the Six Stock Portfolio and is on my Stocks to Watch list.
** ~ $ 22 billion based upon the initial lowered from price target of $19/share*1.155 billion shares outstanding (based upon the latest 8-K at that time); ~ $ 10 billion using the price target of $ 9/share*1.155 billion shares; ~ $ 66 billion at the price target of $ 55/share* 1.191 shares (share count was slightly higher by April of 2010 based upon the latest 8-K at the time).
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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.
Huh?
Sorry, but the intrinsic value of a business like American Express just does not change that much in such a short time frame.
Now, I realize these upgrades/downgrades are likely for market participants with a shorter time horizon but, practically speaking, it makes sense to step back a bit. A little less focus on potential near-term price action and more emphasis on long-term values goes a long way for those investing with a long time horizon in mind.
Trading is about price action. Investing is about what the underlying asset is going to produce over a long time frame.
When it comes to getting satisfactory or better LONG-TERM investing results, estimating what a business is intrinsically worth per share (and the rate that value is likely to increase over time) matters.
Buying shares at a nice discount to that conservative estimate of value also matters.
How the shares might temporarily trade in the near-term or even longer also matters but the reasons may be less intuitive.
(It's a good thing if a stock that's been bought below per share intrinsic value drops further since it allows for more shares to be accumulated cheap. Even for those shareholders who don't want to own more shares it's a good thing. A cheap stock allows each dollar spent on share repurchases to go further. The longer the cheap stock persists, the more it boosts long-term returns. Obviously, no one complains about a stock that rallies right after they buy it. Yet that's actually not the best outcome for those interested in long-term effects.)
To me, it is better to use energy judging whether an understandable business (understandable is, of course, necessarily very much down to individual investors strengths and limits) has durable, attractive economics and, if it does, what the shares are likely to be worth over the longer run. Hardly an easy thing to judge with any precision (more a range of values) but, with some work, occasionally doable.
In my view, investing is mostly about whether the price provides sufficient margin of safety and an attractive long-term return considering the specific risks (and in relation to investing alternatives).
Generally speaking, investing requires discipline, patience, and an even temperament. It's not just judging what something is intrinsically worth based upon what's quantifiable then buying shares at a discount. That's important but insufficient. A bunch of subjective and qualitative judgments have to also be made since much of what counts is not quantifiable.
Yet, none of this is exactly rocket science. With all of this in mind, I'm just saying that trying to guess the near term price action of a stock, then somehow successfully trading around it, seems like an extremely poor use of energy.
Adam
Long position in AXP
* AXP remains a core holding in the Six Stock Portfolio and is on my Stocks to Watch list.
** ~ $ 22 billion based upon the initial lowered from price target of $19/share*1.155 billion shares outstanding (based upon the latest 8-K at that time); ~ $ 10 billion using the price target of $ 9/share*1.155 billion shares; ~ $ 66 billion at the price target of $ 55/share* 1.191 shares (share count was slightly higher by April of 2010 based upon the latest 8-K at the time).
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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.
Weitz: Undervalued Large Caps
From the Weitz Quarterly Letter:
During the late 1990’s, large capitalization growth stocks—especially those with any connection to technology and the Internet—were stock market leaders. Investors were so focused on the largest 25-50 stocks that these stocks became over-valued (and the small- and mid-cap companies’ stocks languished at relatively cheap valuation levels).
Since then, the tables have turned. Over the past ten years, the small-cap Russell 2000 Index has risen by 3% per year (or 34% on a cumulative basis) while the large company-dominated S&P 500 has actually declined by -1.6% per year (or a cumulative -15%). During this period, many of the large- and mega-cap companies grew nicely, but their valuations shrank. For example, suppose a company earned $1 per share in 2000 and sold at 30 times earnings, or $30. If earnings tripled over the next ten years to $3 per share but the price-earnings ratio fell to 10 times, the stock would trade at the same $30 per share, even though its business was clearly more valuable ten years later.
There are a number of reasons for this reversal of fortunes. We believe that the most important is that "value matters" and since the large-cap growth companies entered the decade over-valued relative to the smaller companies (thanks to the tech bubble), it was natural that they under-performed in the subsequent ten years. Another factor was the shift in asset allocation by pension and endowment fund managers from U.S. (primarily large-cap) stocks to private equity and hedge fund "alternative investments" over the past ten years. Also, since all of these companies are global businesses, there is probably concern that the European debt crisis will depress their earnings. Finally, "performance chasing" investors probably helped carry this trend too far by selling their stock laggards and buying those that were "working." Whatever the reasons, the result is that a number of terrific companies with many good years of growth in front of them are selling at very cheap prices.
Yet another money manager with the view that some of the best large businesses are selling at very reasonable prices these days.
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.
During the late 1990’s, large capitalization growth stocks—especially those with any connection to technology and the Internet—were stock market leaders. Investors were so focused on the largest 25-50 stocks that these stocks became over-valued (and the small- and mid-cap companies’ stocks languished at relatively cheap valuation levels).
Since then, the tables have turned. Over the past ten years, the small-cap Russell 2000 Index has risen by 3% per year (or 34% on a cumulative basis) while the large company-dominated S&P 500 has actually declined by -1.6% per year (or a cumulative -15%). During this period, many of the large- and mega-cap companies grew nicely, but their valuations shrank. For example, suppose a company earned $1 per share in 2000 and sold at 30 times earnings, or $30. If earnings tripled over the next ten years to $3 per share but the price-earnings ratio fell to 10 times, the stock would trade at the same $30 per share, even though its business was clearly more valuable ten years later.
There are a number of reasons for this reversal of fortunes. We believe that the most important is that "value matters" and since the large-cap growth companies entered the decade over-valued relative to the smaller companies (thanks to the tech bubble), it was natural that they under-performed in the subsequent ten years. Another factor was the shift in asset allocation by pension and endowment fund managers from U.S. (primarily large-cap) stocks to private equity and hedge fund "alternative investments" over the past ten years. Also, since all of these companies are global businesses, there is probably concern that the European debt crisis will depress their earnings. Finally, "performance chasing" investors probably helped carry this trend too far by selling their stock laggards and buying those that were "working." Whatever the reasons, the result is that a number of terrific companies with many good years of growth in front of them are selling at very cheap prices.
Yet another money manager with the view that some of the best large businesses are selling at very reasonable prices these days.
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.
Wednesday, August 4, 2010
Diageo's Global Brands
Diageo has 8 of the top 20 global spirits brands. It's spirits portfolio includes Smirnoff, Baileys, Johnnie Walker, Jose Cuervo, Tanqueray, and Captain Morgan (among others) while the beer portfolio includes Guinness and Harp.
Here's an article presenting the bullish case for Diageo (ADR: DEO). I have liked the combination of Diageo's brand and distribution strength for a long time but at the current stock price have concerns with valuation.
Some excerpts from the article:
Diageo's big brands do more than create future growth. They also drive Diageo's massive 40% return on equity – a measure of profitability per unit of equity dollar given to the company. That's one reason its shares have outperformed the S&P 500 by a dividend-adjusted 188% over the past decade.
A full 17% of its sales convert to free cash flow -- the purest measure of both company profitability and ability to pay dividends, better than Anheuser-Busch (NYSE: BUD) at 11%, Constellation Brands (NYSE: STZ) at 6%, and Brown-Forman (NYSE: BF-B) at 16%. They're all good alcohol companies in their own right; I just think Diageo is a little better.
The article also mentions that Diageo has a fair amount of debt. While this is true, the company's predictable earnings stream puts it in a position to easily service that debt.
Back to valuation which is of bigger concern. I continue to like Diageo but these days it is no longer cheap. The above article is being written with Diageo hitting ~$ 70/share. I first highlighted the company as selling well below intrinsic value in this post back in April 2009 when it closed at $ 45.54/share and was selling below 10x earnings. In that post, I said the intrinsic value of Diageo should be between $ 70-80/share in 3 years and that there was a good chance the stock price would close the gap and begin to more closely reflect that intrinsic value. At the current ~$ 70/share, the stock is already selling at the low end of that intrinsic value range and the gap between price to intrinsic value has been largely closed. Since the time of that post the stock (not the intrinsic value) has increased 62% and as a result - while I think it's a great franchise that should increase intrinsic value steadily going forward - it's no longer a bargain.
I also mentioned Diageo in Stocks to Watch on July 21st of last year and it remains on the most recent watch list selling well above the max price I'm willing to pay.
Diageo's stock is not extremely expensive selling at ~15-16x earnings but has just become difficult to buy with a sufficient margin of safety. Hopefully, the price will get below $ 60 again.
Adam
Long position in DEO
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.
Tuesday, August 3, 2010
The "Double-Dip" Debate
Each day there seems to be another opinion or someone else weighing in on the "double-dip"/no "double-dip" debate.
Double-dip has become a favorite search term. You will hear and read plenty of opinions on this subject all day. I personally don't have/have not had an opinion. To me, finding situations where businesses are mispriced may not exactly be easy but seems doable and worthwhile by comparison.
Predicting what the entire economy is going to do? No idea.
Predicting the future of an individual company? Possible.
So count me out of the whether the economy will "double-dip" debate but at least we have Seinfeld to fall back on whenever that term gets used.
Video: George Costanza & Timmy Debate Double Dip
George takes a chip from the bowl, dips it, takes a bite, and then dips again. Timmy, the brother of George's girlfriend, then rushes over.
Timmy: What are you doing?
George: What?
Timmy: Did, did you just double dip that chip?
George: Excuse me?
Timmy: You double dipped the chip!
George: Double dipped? What, what are you talking about?
Timmy: You dipped the chip. You took a bite, *points at the dip* and you dipped again.
George: So?
Timmy: That's like putting your whole mouth right in the dip. From now on, when you take a chip, just take one dip and end it.
George: Well, I'm sorry, Timmy, but I don't dip that way.
Timmy: Oh, you don't, huh?
George: No. You dip the way you wanna dip. I'll dip the way I wanna dip.
(George grabs another chip, dips it, takes a bite and begins to reach for the dip as Timmy grabs his hand)
Timmy: Gimme the chip!
(The argument becomes an all-out brawl between George and Timmy)
Other than Seinfeld, I've had enough of the double-dip debate.
If there happens to be one, that just means shares of good businesses will likely get cheaper which is a good thing for those with a longer horizon.
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.
Double-dip has become a favorite search term. You will hear and read plenty of opinions on this subject all day. I personally don't have/have not had an opinion. To me, finding situations where businesses are mispriced may not exactly be easy but seems doable and worthwhile by comparison.
Predicting what the entire economy is going to do? No idea.
Predicting the future of an individual company? Possible.
So count me out of the whether the economy will "double-dip" debate but at least we have Seinfeld to fall back on whenever that term gets used.
Video: George Costanza & Timmy Debate Double Dip
George takes a chip from the bowl, dips it, takes a bite, and then dips again. Timmy, the brother of George's girlfriend, then rushes over.
Timmy: What are you doing?
George: What?
Timmy: Did, did you just double dip that chip?
George: Excuse me?
Timmy: You double dipped the chip!
George: Double dipped? What, what are you talking about?
Timmy: You dipped the chip. You took a bite, *points at the dip* and you dipped again.
George: So?
Timmy: That's like putting your whole mouth right in the dip. From now on, when you take a chip, just take one dip and end it.
George: Well, I'm sorry, Timmy, but I don't dip that way.
Timmy: Oh, you don't, huh?
George: No. You dip the way you wanna dip. I'll dip the way I wanna dip.
(George grabs another chip, dips it, takes a bite and begins to reach for the dip as Timmy grabs his hand)
Timmy: Gimme the chip!
(The argument becomes an all-out brawl between George and Timmy)
Other than Seinfeld, I've had enough of the double-dip debate.
If there happens to be one, that just means shares of good businesses will likely get cheaper which is a good thing for those with a longer horizon.
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.
The Wells Advantage
Bank stocks are tough to evaluate. Look at the 10-K of a large bank versus something like Rocky Mountain Chocolate Factory (RMCF). If that doesn't convince you to never invest in a bank I don't know what will.
(BTW: I am saying this as a long-term investor in Wells Fargo.)
One important factor for all banks is net interest margin (the spread between funding costs & the yield it earns on assets). A bank with greater net interest margin will, all things being equal, have superior return on equity (ROE) and a greater ability to absorb credit losses in periods of economic stress.
There is a good chart in this Wall Street Journal article that shows the significant net interest margin advantage Wells Fargo (WFC) has over other banks.
Net Interest Margin
Wells Fargo: 4.38%
Citigroup (C): 3.15%
J.P. Morgan Chase (JPM): 3.06%
Bank of America (BAC): 2.77%
To simplify, if two banks happened to have $ 1 trillion in assets and similar asset quality, the bank with a 1.2% net interest margin advantage would earn $ 12 billion/year (.012 times $1,000,000,000,000) more pre-tax, pre-provision for losses than its competitors. Again, all things being equal (In reality each of the 4 large banks have unique risks, strengths and weaknesses). That extra $12 billion/year can either go to the bottom line after tax during the good times (building capital) or absorb $ 12 billion more pre-tax* losses than its competitors during bad times (enhancing durability).
Now, from the above chart you can see that this kind of advantage is not far fetched as Wells has at least that much advantage in net interest margin over the three other banks. From the WSJ article:
Wells's cheap funding stems from its large, sticky deposit base.
Wells can absorb significantly more in losses as a % of its assets before going into the red. Over an economic cycle, those cheap funding costs, better yielding assets, and resulting higher net interest margin should allow Wells to:
"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."
He then added...
"...that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently."
As Buffett also pointed out last year, part of the Wells advantage comes from the simple fact that Wells Fargo runs its bank in a way that provides it with relatively lower cost of funding. Here's what he said to CNBC back in May of 2009:
"Wells Fargo obtains their money, which is the raw material, they obtain their money cheaper than anybody else...If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot."
Ultimately, Wells Fargo was required to raise capital after the stress tests.**
From this Bloomberg article:
"I think I know their future, frankly, better than somebody that comes in to take a look," Buffett said yesterday of the bank stocks that Omaha, Nebraska-based Berkshire owns. Regulators, "may be using more of a checklist-type approach."
Buffett Dismisses Government Stress Tests
Buffett said the above things when most analysts were downgrading the stock.
Price targets for the stock were being lowered to single digits.
The results of the stress tests did require Wells Fargo to raise capital, but it seems clear now that the assumptions in the test underestimated the bank's capacity to generate revenues and earnings.
In the end, I think those who look at Wells Fargo's persistently superior revenue generation and earnings power objectively, it's rather clear that Buffett was right.
I first mentioned Wells Fargo as a stock I like*** here on April 9th, 2009 when it was selling for less than $ 20/share. The capital raising certainly did not help shareholders, but the stock is selling at $ 28 now and -- short of another forced capital raise -- should see some nice increases to per share intrinsic value over the long haul.
Right now, Wells is still working through the integration and repair of Wachovia post-acquisition, but over time have proven that they are rather good at banking. As they come to grips with the Wachovia challenges, it should become an increasingly valuable part of this banking franchise.
Adam
Long RMCF, WFC, C, and BAC
* Pre-tax because a business, bank or otherwise, can absorb losses on a pre-tax basis.
** In my opinion, Wells Fargo did not need to raise more capital after the stress test. They had lower tangible common equity due to the acquisition of Wachovia but the stress tests underestimated Wells's capacity to generate revenues and higher returns relative to its competitors. The quarters that have gone by since the test have confirmed this. While it may not have been fair to Wells Fargo I happen to still think it was the right thing to do for overall financial system integrity. Such is the nature of investing in banks. The risk is always there that regulators will force some dilution on the existing equity holders for the greater good of the system.
*** 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.
(BTW: I am saying this as a long-term investor in Wells Fargo.)
One important factor for all banks is net interest margin (the spread between funding costs & the yield it earns on assets). A bank with greater net interest margin will, all things being equal, have superior return on equity (ROE) and a greater ability to absorb credit losses in periods of economic stress.
There is a good chart in this Wall Street Journal article that shows the significant net interest margin advantage Wells Fargo (WFC) has over other banks.
Net Interest Margin
Wells Fargo: 4.38%
Citigroup (C): 3.15%
J.P. Morgan Chase (JPM): 3.06%
Bank of America (BAC): 2.77%
To simplify, if two banks happened to have $ 1 trillion in assets and similar asset quality, the bank with a 1.2% net interest margin advantage would earn $ 12 billion/year (.012 times $1,000,000,000,000) more pre-tax, pre-provision for losses than its competitors. Again, all things being equal (In reality each of the 4 large banks have unique risks, strengths and weaknesses). That extra $12 billion/year can either go to the bottom line after tax during the good times (building capital) or absorb $ 12 billion more pre-tax* losses than its competitors during bad times (enhancing durability).
Now, from the above chart you can see that this kind of advantage is not far fetched as Wells has at least that much advantage in net interest margin over the three other banks. From the WSJ article:
Wells's cheap funding stems from its large, sticky deposit base.
Wells can absorb significantly more in losses as a % of its assets before going into the red. Over an economic cycle, those cheap funding costs, better yielding assets, and resulting higher net interest margin should allow Wells to:
- Generate an after tax ROE in the high teens while its competitors earn an ROE in the low teens
- Have a much greater ability to remain profitable during times of economic stress
- Use its greater earning capacity to provide a buffer against needing more capital
"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."
He then added...
"...that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently."
As Buffett also pointed out last year, part of the Wells advantage comes from the simple fact that Wells Fargo runs its bank in a way that provides it with relatively lower cost of funding. Here's what he said to CNBC back in May of 2009:
"Wells Fargo obtains their money, which is the raw material, they obtain their money cheaper than anybody else...If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot."
Ultimately, Wells Fargo was required to raise capital after the stress tests.**
From this Bloomberg article:
"I think I know their future, frankly, better than somebody that comes in to take a look," Buffett said yesterday of the bank stocks that Omaha, Nebraska-based Berkshire owns. Regulators, "may be using more of a checklist-type approach."
Buffett Dismisses Government Stress Tests
Buffett said the above things when most analysts were downgrading the stock.
Price targets for the stock were being lowered to single digits.
The results of the stress tests did require Wells Fargo to raise capital, but it seems clear now that the assumptions in the test underestimated the bank's capacity to generate revenues and earnings.
In the end, I think those who look at Wells Fargo's persistently superior revenue generation and earnings power objectively, it's rather clear that Buffett was right.
I first mentioned Wells Fargo as a stock I like*** here on April 9th, 2009 when it was selling for less than $ 20/share. The capital raising certainly did not help shareholders, but the stock is selling at $ 28 now and -- short of another forced capital raise -- should see some nice increases to per share intrinsic value over the long haul.
Right now, Wells is still working through the integration and repair of Wachovia post-acquisition, but over time have proven that they are rather good at banking. As they come to grips with the Wachovia challenges, it should become an increasingly valuable part of this banking franchise.
Adam
Long RMCF, WFC, C, and BAC
* Pre-tax because a business, bank or otherwise, can absorb losses on a pre-tax basis.
** In my opinion, Wells Fargo did not need to raise more capital after the stress test. They had lower tangible common equity due to the acquisition of Wachovia but the stress tests underestimated Wells's capacity to generate revenues and higher returns relative to its competitors. The quarters that have gone by since the test have confirmed this. While it may not have been fair to Wells Fargo I happen to still think it was the right thing to do for overall financial system integrity. Such is the nature of investing in banks. The risk is always there that regulators will force some dilution on the existing equity holders for the greater good of the system.
*** 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, August 2, 2010
Coca-Cola's CEO: "North America will be a growth market"
Some comments from Coca-Cola's (KO) CEO Muhtar Kent during the 2Q Earnings Conference Call:
Coca-Cola Q2 2010 Earnings Call Transcript
"The global equity of our brands is strong and growing stronger. Our worldwide FIFA World Cup activation was a tremendous success, bringing Coca-Cola to billions of consumers across cities, across towns, villages and living rooms the world over. Consumers clearly continue to prefer our brand with brand Coca-Cola growing 5% for the quarter and 4% year-to-date.
Additionally, we saw extensive share gains this quarter across key beverage categories, including sparkling, packaged water, ready-to-drink juice and juice drinks as well as sports drinks. As a result, we gained volume and value share in global non-alcoholic ready-to-drink beverages. We also gained global volume and value share in both the sparkling and still beverage categories."
During the conference call, Muhtar Kent also said that North America will become a growth market again.
"North America will be a growth market of great opportunities for the next 10 years and beyond."
That's certainly at least somewhat surprising.
Adam
Long KO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Coca-Cola Q2 2010 Earnings Call Transcript
"The global equity of our brands is strong and growing stronger. Our worldwide FIFA World Cup activation was a tremendous success, bringing Coca-Cola to billions of consumers across cities, across towns, villages and living rooms the world over. Consumers clearly continue to prefer our brand with brand Coca-Cola growing 5% for the quarter and 4% year-to-date.
Additionally, we saw extensive share gains this quarter across key beverage categories, including sparkling, packaged water, ready-to-drink juice and juice drinks as well as sports drinks. As a result, we gained volume and value share in global non-alcoholic ready-to-drink beverages. We also gained global volume and value share in both the sparkling and still beverage categories."
During the conference call, Muhtar Kent also said that North America will become a growth market again.
"North America will be a growth market of great opportunities for the next 10 years and beyond."
That's certainly at least somewhat surprising.
Adam
Long KO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Buffett: The Test of Managerial Performance - Berkshire Shareholder Letter Highlights
Warren Buffett wrote the following in the 1979 Berkshire Hathaway (BRKa) shareholder letter:
The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure.
It's not about earnings growth in a vacuum. A business generating high returns on capital combined with a management team that understands the "primary test" of performance will produce favorable long-term shareholder returns.
The business must be capable of generating increases to earnings with small amounts of incremental capital yet remain competitive.
Many businesses fail on that last part. To remain competitive most businesses need substantial amounts of additional capital.
See's Candies is a very good example of a business that needs little incremental capital yet remains competitive while producing outstanding returns on capital. As a result, shareholders are consistently enriched.
Adam
Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure.
It's not about earnings growth in a vacuum. A business generating high returns on capital combined with a management team that understands the "primary test" of performance will produce favorable long-term shareholder returns.
The business must be capable of generating increases to earnings with small amounts of incremental capital yet remain competitive.
Many businesses fail on that last part. To remain competitive most businesses need substantial amounts of additional capital.
See's Candies is a very good example of a business that needs little incremental capital yet remains competitive while producing outstanding returns on capital. As a result, shareholders are consistently enriched.
Adam
Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.