Ahead of Berkshire Hathaway's Shareholder Meeting Warren Buffett said he'd answer all questions about David Sokol:
Fox Business Video
Later in the interview Liz Claman asked whether he'd be saying "no comment" when it comes Sokol:
"You'll not hear no comment. If our lawyer gets up and wrestles me to the ground, I'll still be trying to talk."
Berkshire will post a transcript of all questions and answers related to David Sokol raised at the meeting. While the Sokol stuff is obviously important, I'll be looking forward to moving beyond that issue to the insights on business and investing that typically comes out of the meeting.
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.
Saturday, April 30, 2011
Friday, April 29, 2011
The Apple Decade
Apple's (AAPL) success in recent years is not exactly news but what they've accomplished financially is more than a little bit impressive.
Probably seems strange but just a decade ago Apple was struggling to generate positive earnings.
By 2003, the company was making money but still not able to break through $ 100 million mark in earnings during that year.
Certainly progress, but financially not even close to being in the same league as other big cap tech companies.
In 2004, Apple had grown earnings to $ 276 million. For comparison, Amazon (AMZN) earned slightly more than 2x what Apple earned that year at $ 588 million.
That same year Microsoft (MSFT) earned $ 8.16 billion.
So fast forward to this year. What will Apple likely earn in 2011?
Nearly $ 23 billion or so without even breaking a sweat.
An 83-fold increase in 7 years and, for the first time since 1990, slightly higher than Microsoft.
Company |2011 Est Earnings| Enterprise Value*
Apple | $ 22.9 billion | $ 258 billion
Microsoft| $ 21.8 billion | $ 186 billion
Amazon | $ 1.2 billion | $ 81 billion
So based upon current estimates, Apple will earn every ~19 days what Amazon will make in a year yet market prices imply that Apple is only worth a little bit more than three Amazon's.
Amazingly, considering its star status (at least as far as the stock goes) Amazon has barely been able to double earnings since 2004.
Strong free cash flows and growth prospects are generally the two arguments I hear most often to justify Amazon's valuation.
Amazon's free cash flow** looks unimpressive to me while year over year earnings growth is expected to be ~17%.
Solid.
Sales growth is more impressive at 38%.
Apple's not exactly a slouch when it comes to growth. Apple is growing as fast as just about any business never mind one that's already a giant.
So why no premium for Apple?
Its earnings growth is expected to be more than 60% this year.
Actually, Amazon's earnings growth rate has been less than supposedly stodgy Microsoft since 2004.
Company |2004 Earnings |2011 Est Earnings|% Growth
Amazon | $ 588 million | $ 1.2 billion | 109%
Microsoft | $ 8.16 billion | $ 21.5 billion | 163%
With an enterprise value to earnings of 8.5x, there's nothing wrong with Microsoft's earnings growth. It doesn't need to grow much at all to justify that valuation.
Amazon is no doubt a fine business. The problem is that 67x enterprise value to earnings multiple. Quite a premium to pay for promise that's yet to be realized. I don't doubt that Amazon has a decent probability of eventually growing into that valuation but no one invests to just get their money back. In fact, the likelihood is there that Amazon will actually grow into that valuation and then some at some point down the road.
That's still not necessarily enough to justify current prices.
The question is: At current prices, does the Amazon investor have a good chance of being compensated for the risks relative to investment alternatives?
In my book paying that kind of multiple takes away the necessary cushion for the inevitable unexpected thing or two going wrong.
Apple naturally has its own set of risks but has been growing and continues to grow earnings faster than just about any business. Yet, Apple has an enterprise value to this year's expected earnings of 11.3x. In contrast to Amazon, it seems Apple has that cushion against the unexpected. So somewhat oddly (considering all that has been accomplished) at current prices there's still no apparent premium in Apple's equity.
At the end of its most recent quarter, there was ~$ 66 billion of cash and investments on Apple's balance sheet that will easily grow to more than $ 80 billion by the end of 2011.
The company has no debt.
A remarkable situation, but there's still just no technology business that I'm comfortable with as a long-term investment. Occasionally, certain tech stocks have sold at enough of a discount to be worth the headache of ownership, in small quantities, for my own portfolio. They will always remain, at most, very small positions. Most tech businesses are involved in exciting, dynamic, and highly competitive industries. That's precisely what makes them unattractive long-term investments.
No matter how good business looks today (or how high the expectations are), it's just not that easy to predict their economic prospects many years from now.
With the best businesses that's not the case.
Adam
Long positions in AAPL and MSFT
* Enterprise Value = Market Capitalization - Net Cash
** Basically, much of Amazon's free cash flow comes from growth in accounts payable relative to accounts receivable. While a company is growing fast that's a fine source of "float" but not exactly the highest quality operating cash flow.
---
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.
Probably seems strange but just a decade ago Apple was struggling to generate positive earnings.
By 2003, the company was making money but still not able to break through $ 100 million mark in earnings during that year.
Certainly progress, but financially not even close to being in the same league as other big cap tech companies.
In 2004, Apple had grown earnings to $ 276 million. For comparison, Amazon (AMZN) earned slightly more than 2x what Apple earned that year at $ 588 million.
That same year Microsoft (MSFT) earned $ 8.16 billion.
So fast forward to this year. What will Apple likely earn in 2011?
Nearly $ 23 billion or so without even breaking a sweat.
An 83-fold increase in 7 years and, for the first time since 1990, slightly higher than Microsoft.
Company |2011 Est Earnings| Enterprise Value*
Apple | $ 22.9 billion | $ 258 billion
Microsoft| $ 21.8 billion | $ 186 billion
Amazon | $ 1.2 billion | $ 81 billion
So based upon current estimates, Apple will earn every ~19 days what Amazon will make in a year yet market prices imply that Apple is only worth a little bit more than three Amazon's.
Amazingly, considering its star status (at least as far as the stock goes) Amazon has barely been able to double earnings since 2004.
Strong free cash flows and growth prospects are generally the two arguments I hear most often to justify Amazon's valuation.
Amazon's free cash flow** looks unimpressive to me while year over year earnings growth is expected to be ~17%.
Solid.
Sales growth is more impressive at 38%.
Apple's not exactly a slouch when it comes to growth. Apple is growing as fast as just about any business never mind one that's already a giant.
So why no premium for Apple?
Its earnings growth is expected to be more than 60% this year.
Actually, Amazon's earnings growth rate has been less than supposedly stodgy Microsoft since 2004.
Company |2004 Earnings |2011 Est Earnings|% Growth
Amazon | $ 588 million | $ 1.2 billion | 109%
Microsoft | $ 8.16 billion | $ 21.5 billion | 163%
With an enterprise value to earnings of 8.5x, there's nothing wrong with Microsoft's earnings growth. It doesn't need to grow much at all to justify that valuation.
Amazon is no doubt a fine business. The problem is that 67x enterprise value to earnings multiple. Quite a premium to pay for promise that's yet to be realized. I don't doubt that Amazon has a decent probability of eventually growing into that valuation but no one invests to just get their money back. In fact, the likelihood is there that Amazon will actually grow into that valuation and then some at some point down the road.
That's still not necessarily enough to justify current prices.
The question is: At current prices, does the Amazon investor have a good chance of being compensated for the risks relative to investment alternatives?
In my book paying that kind of multiple takes away the necessary cushion for the inevitable unexpected thing or two going wrong.
Apple naturally has its own set of risks but has been growing and continues to grow earnings faster than just about any business. Yet, Apple has an enterprise value to this year's expected earnings of 11.3x. In contrast to Amazon, it seems Apple has that cushion against the unexpected. So somewhat oddly (considering all that has been accomplished) at current prices there's still no apparent premium in Apple's equity.
At the end of its most recent quarter, there was ~$ 66 billion of cash and investments on Apple's balance sheet that will easily grow to more than $ 80 billion by the end of 2011.
The company has no debt.
A remarkable situation, but there's still just no technology business that I'm comfortable with as a long-term investment. Occasionally, certain tech stocks have sold at enough of a discount to be worth the headache of ownership, in small quantities, for my own portfolio. They will always remain, at most, very small positions. Most tech businesses are involved in exciting, dynamic, and highly competitive industries. That's precisely what makes them unattractive long-term investments.
No matter how good business looks today (or how high the expectations are), it's just not that easy to predict their economic prospects many years from now.
With the best businesses that's not the case.
Adam
Long positions in AAPL and MSFT
* Enterprise Value = Market Capitalization - Net Cash
** Basically, much of Amazon's free cash flow comes from growth in accounts payable relative to accounts receivable. While a company is growing fast that's a fine source of "float" but not exactly the highest quality operating cash flow.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, April 28, 2011
The Best IPO Market on Earth
The U.S. IPO market has historically been an economic force. I recently watched this interview on Bloomberg with David Weild of Grant Thornton.
Weild argues that changes in market structure over the past decade or so has reduced the number of IPOs in the United States.
In his view, these changes have contributed directly to reduced U.S. economic prosperity and increased unemployment.
In his view, these changes have contributed directly to reduced U.S. economic prosperity and increased unemployment.
This report published in June of last year that Weild co-authored provides some background:
...since 2001 the U.S. has averaged only 126 IPOs per year, with only 38 in 2008 and 61 in 2009 - this compared to the headiness of 1991–2000 with averages of 530 IPOs per year. Companies can no longer rely on the U.S. capital markets for an infusion of capital, nor can they turn to credit-strapped banks. The result? Companies are unable to expand and grow - they are unable to innovate and compete - so they are left to wither and die, contributing to today’s high unemployment rate.
Market Structure is at Fault
The IPO Crisis is primarily a market-structure-caused crisis, the roots of which date back at least to 1997. The erosion in the U.S. IPO market can be seen as the perfect storm of unintended consequences from the cumulative effects of uncoordinated regulatory changes and inevitable technology advances - all of which stripped away the economic model that once supported investors and small cap companies with capital commitment, sales support and high quality research.
Casino Capitalism
the current stock market model forces Wall Street to cater to high-frequency trading accounts at the expense of long-term investors, and that Wall Street is increasingly out of touch with the interests and needs of long-term equity investors.
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"By killing the IPO goose that laid the golden egg of U.S. economic growth, technology, legislation and regulation undermined investment in small cap stocks, drove speculation and killed the best IPO market on earth." - David Weild
Ultimately, it has been the smallest IPOs that have taken the biggest hit.
...small IPOs - those under $25 million in size - suffered a rapid decline from 1996 to 2000. Interestingly, the small IPOs were seeing steady downward pressure at the same time that online brokerage was booming and displacing stockbrokers.
Before the rapid decline started in the late 1990s, IPOs under $ 25 million in size were routinely in the 200-300 per year range.
The peak year since then?
Less than 30.
A serious deterioration in something that was historically a source of economic strength for the United States.
The problem needs to be seen for what it is but, with the right reforms, I think there's no doubt it can be fixed.
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.
Sokol: Under the Bus
As of yesterday, when it comes to David Sokol their has been quite a change in tone coming from Berkshire Hathaway compared to the one found in the letter that Warren Buffett wrote less than a month ago.
Up to now, Buffett's handling of Sokol's departure has brought on a fair amount of criticism.
From the 18-page report released yesterday by the Berkshire Hathaway (BRKa) Audit Committee:
Berkshire Hathaway's top priority is to maintain the highest standards of business ethics. Company policies require the employees of Berkshire Hathaway and its subsidiaries to uphold those standards. The Audit Committee has considered the conduct of David Sokol in connection with his trading in the shares of Lubrizol, and has determined that it violated those standards. In particular:
-His purchases of Lubrizol shares while serving as a representative of Berkshire Hathaway in connection with a possible business combination with Lubrizol violated company policies, including Berkshire Hathaway's Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures.
-His misleadingly incomplete disclosures to Berkshire Hathaway senior management concerning those purchases violated the duty of candor he owed the Company.
-These events should serve as an opportunity to reinforce to all officers, directors and employees of Berkshire Hathaway and its subsidiaries the importance of adhering to those policies and avoiding conduct that comes close to, or strays over, the line of propriety. To that end, we authorize Warren Buffett to release this report.
The report more or less portrays Buffett as a victim of deception and said the company should weigh suing Sokol.
From this Bloomberg article:
"They're throwing Sokol under the bus," said Stephen Bainbridge, a professor at the UCLA School of Law who has written and taught about corporate governance.
A separate Bloomberg article added this point of view:
It's certainly not the outcome any who knew Sokol imagined for the assertive executive, who was not born to power or wealth and relied on his energy, competitiveness, and outsider's will to become the ultimate insider, Omaha-style...
Later in the same article...
"About the smartest business guy I know," [Terry L.] Moore says. "We're all baffled by this -- what happened, and why did it happen?"
The Berkshire committee's report provided a devastating version of the "what," suggesting that Sokol "intended to deceive" Buffett about several key aspects of the Lubrizol episode.
The "why" remains more of a mystery: Why was Sokol, already a rich man with a vacation retreat near Jackson Hole, Wyoming, and a yacht to go with a third home in Fort Lauderdale, dabbling in the stock of a company he suggested that his boss acquire?
On Wall Street, this kind of trading is often considered front-running. It's usually a firing offense, if not necessarily illegal.
From heir apparent to this.
Baffling.
Adam
Up to now, Buffett's handling of Sokol's departure has brought on a fair amount of criticism.
From the 18-page report released yesterday by the Berkshire Hathaway (BRKa) Audit Committee:
Berkshire Hathaway's top priority is to maintain the highest standards of business ethics. Company policies require the employees of Berkshire Hathaway and its subsidiaries to uphold those standards. The Audit Committee has considered the conduct of David Sokol in connection with his trading in the shares of Lubrizol, and has determined that it violated those standards. In particular:
-His purchases of Lubrizol shares while serving as a representative of Berkshire Hathaway in connection with a possible business combination with Lubrizol violated company policies, including Berkshire Hathaway's Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures.
-His misleadingly incomplete disclosures to Berkshire Hathaway senior management concerning those purchases violated the duty of candor he owed the Company.
-These events should serve as an opportunity to reinforce to all officers, directors and employees of Berkshire Hathaway and its subsidiaries the importance of adhering to those policies and avoiding conduct that comes close to, or strays over, the line of propriety. To that end, we authorize Warren Buffett to release this report.
The report more or less portrays Buffett as a victim of deception and said the company should weigh suing Sokol.
From this Bloomberg article:
"They're throwing Sokol under the bus," said Stephen Bainbridge, a professor at the UCLA School of Law who has written and taught about corporate governance.
A separate Bloomberg article added this point of view:
It's certainly not the outcome any who knew Sokol imagined for the assertive executive, who was not born to power or wealth and relied on his energy, competitiveness, and outsider's will to become the ultimate insider, Omaha-style...
Later in the same article...
"About the smartest business guy I know," [Terry L.] Moore says. "We're all baffled by this -- what happened, and why did it happen?"
The Berkshire committee's report provided a devastating version of the "what," suggesting that Sokol "intended to deceive" Buffett about several key aspects of the Lubrizol episode.
The "why" remains more of a mystery: Why was Sokol, already a rich man with a vacation retreat near Jackson Hole, Wyoming, and a yacht to go with a third home in Fort Lauderdale, dabbling in the stock of a company he suggested that his boss acquire?
On Wall Street, this kind of trading is often considered front-running. It's usually a firing offense, if not necessarily illegal.
From heir apparent to this.
Baffling.
Adam
Wednesday, April 27, 2011
The Economic Illusion: Berkshire Shareholder Letter Highlights
"It has been far safer to steal large sums with a pen than small sums with a gun." - Warren Buffett in the 1988 Berkshire Hathaway (BRKa) shareholder letter
I mentioned in this previous post that the heavy reliance on non-GAAP earnings by some companies are, if not a red flag, often simply a way for management to present an overly optimistic view (and, of course, in some cases total BS).
It's also true that GAAP has severe limitations so you can hardly count on the reported numbers alone to paint a meaningful economic picture. That's part of what makes interpreting, in a meaningful economic sense, what is going on with any company so tricky. In a perfect world, every CEO would make sure owners/creditors understand and are as informed as possible by the financial information provided.
In reality, the accounting culture can be vastly different from one business to the next.
GAAP is not gospel.
Warren Buffett provides some insights into this dilemma in the 1988 Berkshire letter:
"Despite the shortcomings of generally accepted accounting principles (GAAP), I would hate to have the job of devising a better set of rules. The limitations of the existing set, however, need not be inhibiting: CEOs are free to treat GAAP statements as a beginning rather than an end to their obligation to inform owners and creditors - and indeed they should. After all, any manager of a subsidiary company would find himself in hot water if he reported barebones GAAP numbers that omitted key information needed by his boss, the parent corporation’s CEO. Why, then, should the CEO himself withhold information vitally useful to his bosses - the shareholder-owners of the corporation?
What needs to be reported is data - whether GAAP, non-GAAP, or extra-GAAP - that helps financially-literate readers answer three key questions: (1) Approximately how much is this company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?
In most cases, answers to one or more of these questions are somewhere between difficult and impossible to glean from the minimum GAAP presentation. The business world is simply too complex for a single set of rules to effectively describe economic reality for all enterprises, particularly those operating in a wide variety of businesses, such as Berkshire.
Further complicating the problem is the fact that many managements view GAAP not as a standard to be met, but as an obstacle to overcome. Too often their accountants willingly assist them. (“How much,” says the client, “is two plus two?” Replies the cooperative accountant, “What number did you have in mind?”) Even honest and well-intentioned managements sometimes stretch GAAP a bit in order to present figures they think will more appropriately describe their performance. Both the smoothing of earnings and the "big bath" quarter are "white lie" techniques employed by otherwise upright managements.
Then there are managers who actively use GAAP to deceive and defraud. They know that many investors and creditors accept GAAP results as gospel. So these charlatans interpret the rules "imaginatively" and record business transactions in ways that technically comply with GAAP but actually display an economic illusion to the world.
As long as investors - including supposedly sophisticated institutions - place fancy valuations on reported "earnings" that march steadily upward, you can be sure that some managers and promoters will exploit GAAP to produce such numbers, no matter what the truth may be. Over the years, Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished; many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun."
I try to keep what Buffett says above in mind when pouring through financial statements during reporting season. The bottom line is it's easier to invest in a business knowing the management team reinforces a culture of conservative accounting practices and transparency. Seems like something to take for granted but it is not. If necessary, I'd buy a slightly inferior business knowing that management would generally report conservatively and honestly (of course, I'll take the best of both worlds anyday).
A business with that kind of culture hardly eliminates all risks but at least reduces the probability of unnecessary surprises.
Knowing that the reported financials are likely to do a reasonably good job of reflecting economic reality makes investing, which is already difficult enough, just a little bit easier.
Adam
Long BRKb
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
I mentioned in this previous post that the heavy reliance on non-GAAP earnings by some companies are, if not a red flag, often simply a way for management to present an overly optimistic view (and, of course, in some cases total BS).
It's also true that GAAP has severe limitations so you can hardly count on the reported numbers alone to paint a meaningful economic picture. That's part of what makes interpreting, in a meaningful economic sense, what is going on with any company so tricky. In a perfect world, every CEO would make sure owners/creditors understand and are as informed as possible by the financial information provided.
In reality, the accounting culture can be vastly different from one business to the next.
GAAP is not gospel.
Warren Buffett provides some insights into this dilemma in the 1988 Berkshire letter:
"Despite the shortcomings of generally accepted accounting principles (GAAP), I would hate to have the job of devising a better set of rules. The limitations of the existing set, however, need not be inhibiting: CEOs are free to treat GAAP statements as a beginning rather than an end to their obligation to inform owners and creditors - and indeed they should. After all, any manager of a subsidiary company would find himself in hot water if he reported barebones GAAP numbers that omitted key information needed by his boss, the parent corporation’s CEO. Why, then, should the CEO himself withhold information vitally useful to his bosses - the shareholder-owners of the corporation?
What needs to be reported is data - whether GAAP, non-GAAP, or extra-GAAP - that helps financially-literate readers answer three key questions: (1) Approximately how much is this company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?
In most cases, answers to one or more of these questions are somewhere between difficult and impossible to glean from the minimum GAAP presentation. The business world is simply too complex for a single set of rules to effectively describe economic reality for all enterprises, particularly those operating in a wide variety of businesses, such as Berkshire.
Further complicating the problem is the fact that many managements view GAAP not as a standard to be met, but as an obstacle to overcome. Too often their accountants willingly assist them. (“How much,” says the client, “is two plus two?” Replies the cooperative accountant, “What number did you have in mind?”) Even honest and well-intentioned managements sometimes stretch GAAP a bit in order to present figures they think will more appropriately describe their performance. Both the smoothing of earnings and the "big bath" quarter are "white lie" techniques employed by otherwise upright managements.
Then there are managers who actively use GAAP to deceive and defraud. They know that many investors and creditors accept GAAP results as gospel. So these charlatans interpret the rules "imaginatively" and record business transactions in ways that technically comply with GAAP but actually display an economic illusion to the world.
As long as investors - including supposedly sophisticated institutions - place fancy valuations on reported "earnings" that march steadily upward, you can be sure that some managers and promoters will exploit GAAP to produce such numbers, no matter what the truth may be. Over the years, Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished; many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun."
I try to keep what Buffett says above in mind when pouring through financial statements during reporting season. The bottom line is it's easier to invest in a business knowing the management team reinforces a culture of conservative accounting practices and transparency. Seems like something to take for granted but it is not. If necessary, I'd buy a slightly inferior business knowing that management would generally report conservatively and honestly (of course, I'll take the best of both worlds anyday).
A business with that kind of culture hardly eliminates all risks but at least reduces the probability of unnecessary surprises.
Knowing that the reported financials are likely to do a reasonably good job of reflecting economic reality makes investing, which is already difficult enough, just a little bit easier.
Adam
Long BRKb
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Tuesday, April 26, 2011
Dell: Beyond the PC
Michael Dell founded Dell (DELL) back in 1984 and maintains a sizable stake in the company. Late last year, he bought slightly more than $ 100,000,000 of the company's stock at $ 13.57/share. In addition, in March of this year he purchased an additional $ 150,000,000 between $ 14.21 and $ 14.42/share.
Those purchases still seem like real money even for someone with a large sum already invested in the company.
The stock closed at $ 15.38 yesterday giving it an enterprise value of $ 21.7 billion ($ 30 billion market capitalization minus $ 8.3 billion in net cash).
In a recent Wall Street Journal interview he pointed out:
- Two-thirds of Dell's profit is non-PC
- Most of what is PC is not consumer
So Dell's not really a consumer PC company though some seem to still see it that way.
Last year, Dell had net income of $ 2.6 billion. This is a more conservative number than the non-GAAP number of $ 3.1 billion that the company reported.
Free cash flow (GAAP Net Income + Depreciation - CapEx) for the company was nearly $ 3.2 billion. In this case, those healthy free cash flows seem to support the idea that the non-GAAP earnings may be a better reflection of Dell's earning power. Many reported non-GAAP numbers are just a way to provide a slightly optimistic view (a.k.a.: BS).
Either way the company looks not expensive.With Dell expected to have non-GAAP net income of ~$3.3 billion this year the enterprise value to earnings stands at 6.5x. The multiple is more like 7.6x if the more conservative GAAP net income is used.
I'm guessing what seems now "cheap" will just get even cheaper before it is all sorted out among the longer term investors and those more focused on price action. I've said before that there's just no technology business I'm comfortable with as a long-term investment. Occasionally, some have sold at enough of a discount to be worth the trouble, but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries.
That's precisely what makes them unattractive long-term investments.
Adam
Established a small long position in DELL at lower prices
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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.
Those purchases still seem like real money even for someone with a large sum already invested in the company.
The stock closed at $ 15.38 yesterday giving it an enterprise value of $ 21.7 billion ($ 30 billion market capitalization minus $ 8.3 billion in net cash).
In a recent Wall Street Journal interview he pointed out:
- Two-thirds of Dell's profit is non-PC
- Most of what is PC is not consumer
So Dell's not really a consumer PC company though some seem to still see it that way.
Last year, Dell had net income of $ 2.6 billion. This is a more conservative number than the non-GAAP number of $ 3.1 billion that the company reported.
Free cash flow (GAAP Net Income + Depreciation - CapEx) for the company was nearly $ 3.2 billion. In this case, those healthy free cash flows seem to support the idea that the non-GAAP earnings may be a better reflection of Dell's earning power. Many reported non-GAAP numbers are just a way to provide a slightly optimistic view (a.k.a.: BS).
Either way the company looks not expensive.With Dell expected to have non-GAAP net income of ~$3.3 billion this year the enterprise value to earnings stands at 6.5x. The multiple is more like 7.6x if the more conservative GAAP net income is used.
I'm guessing what seems now "cheap" will just get even cheaper before it is all sorted out among the longer term investors and those more focused on price action. I've said before that there's just no technology business I'm comfortable with as a long-term investment. Occasionally, some have sold at enough of a discount to be worth the trouble, but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries.
That's precisely what makes them unattractive long-term investments.
Adam
Established a small long position in DELL at lower prices
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, April 25, 2011
One Fund = 1/3 of all Silver Bullion on Earth
From this recent Jason Zweig article in the Wall Street Journal on the iShares Silver Trust (SLV).
The article points out that the fund is now the 12th largest ETF in the U.S. and holds (get this) one third of all silver on earth.
One fund that owns one-third of ALL the silver bullion on earth?
Geez.
The market in silver operated okay, for quite a long time, before a trading vehicle existed that owned 1 out of every 3 troy ounces of the metal.
So it seems reasonable to ask the following: Does this amount of incremental demand created by these convenient new methods of trading and owning silver cause a slight or even meaningful upward push in the metal's price?
I'd like to hear an unbiased explanation of how that kind and size of structural change doesn't impact prices.
I know that concerns over extremely loose monetary policy by central banks and the resulting lack of trust in paper currencies in general is a fundamental (and maybe even one of the dominant) driver of these price increases.
Makes sense.
That doesn't mean the invention of these (and other) relatively convenient new methods of trading commodities aren't exaggerating the moves.
Both can be true.
In addition, it has been suggested for some commodities that other factors (leverage in the system, inadequate position limits etc.) are distorting prices.
At some point down the road, with the benefit of hindsight, the actual drivers of the huge moves in commodity prices (monetary policy, supply/demand imbalances, leverage, position limits, proliferation of ETFs, etc.) will be easier to understand. There will be no shortage of strong opinions until we do. I don't know the answer. All I know is, historically, an extended period of price increases in any market starts with something fundamentally sound then gets exacerbated by excess.
So yes there are fundamental causes behind these price moves. There are, in many cases, legit supply/demand imbalances and concerns about monetary policy. Still, I won't be surprised when the dust settles if it turns out more than a little bit of these massive increases in price across the commodities complex turns out to be, in part, driven by how convenient it has become (from pension funds to personal brokerage accounts) to trade everything from gold to grains. The amount of leverage being employed will also likely be a factor (explicit or via derivatives). In short, the sheer amount of money that has flooded commodities markets used to end up elsewhere.
The above 4 ETFs are far from an exhaustive list of silver funds but all are relatively new (roughly 5 years old or less...the entire commodity ETF phenomenon began a half decade ago or so but proliferation is a more recent thing).
The newest of the silver ETFs is the Sprott Physical Silver Trust which has been around for ~6 months. Zweig's article points out the silver in the fund is worth $ 18.15/share but the market price is $ 22.11.
A 22 percent premium.
The oldest of these funds is the iShares Silver Trust at roughly five years old. I think five years or so qualifies as too little history to be making a definitive judgment about whether and how much prices are being distorted. Yet, such a small base of experience with relatively new trading vehicles that potentially wield significant influence on behavior (and ultimately prices), at the very least, warrants skepticism and open-minded caution.
What's changed is usually a good place to start in order to understand a problem.
Adam
Related posts:
Michael Masters: Commodities Complex in the Throes of a Bubble
Oil's Endless Bid
Ray Dalio on Stocks & Commodities
Financialization of Copper
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 article points out that the fund is now the 12th largest ETF in the U.S. and holds (get this) one third of all silver on earth.
One fund that owns one-third of ALL the silver bullion on earth?
Geez.
The market in silver operated okay, for quite a long time, before a trading vehicle existed that owned 1 out of every 3 troy ounces of the metal.
So it seems reasonable to ask the following: Does this amount of incremental demand created by these convenient new methods of trading and owning silver cause a slight or even meaningful upward push in the metal's price?
I'd like to hear an unbiased explanation of how that kind and size of structural change doesn't impact prices.
I know that concerns over extremely loose monetary policy by central banks and the resulting lack of trust in paper currencies in general is a fundamental (and maybe even one of the dominant) driver of these price increases.
Makes sense.
That doesn't mean the invention of these (and other) relatively convenient new methods of trading commodities aren't exaggerating the moves.
Both can be true.
In addition, it has been suggested for some commodities that other factors (leverage in the system, inadequate position limits etc.) are distorting prices.
At some point down the road, with the benefit of hindsight, the actual drivers of the huge moves in commodity prices (monetary policy, supply/demand imbalances, leverage, position limits, proliferation of ETFs, etc.) will be easier to understand. There will be no shortage of strong opinions until we do. I don't know the answer. All I know is, historically, an extended period of price increases in any market starts with something fundamentally sound then gets exacerbated by excess.
So yes there are fundamental causes behind these price moves. There are, in many cases, legit supply/demand imbalances and concerns about monetary policy. Still, I won't be surprised when the dust settles if it turns out more than a little bit of these massive increases in price across the commodities complex turns out to be, in part, driven by how convenient it has become (from pension funds to personal brokerage accounts) to trade everything from gold to grains. The amount of leverage being employed will also likely be a factor (explicit or via derivatives). In short, the sheer amount of money that has flooded commodities markets used to end up elsewhere.
The above 4 ETFs are far from an exhaustive list of silver funds but all are relatively new (roughly 5 years old or less...the entire commodity ETF phenomenon began a half decade ago or so but proliferation is a more recent thing).
The newest of the silver ETFs is the Sprott Physical Silver Trust which has been around for ~6 months. Zweig's article points out the silver in the fund is worth $ 18.15/share but the market price is $ 22.11.
A 22 percent premium.
The oldest of these funds is the iShares Silver Trust at roughly five years old. I think five years or so qualifies as too little history to be making a definitive judgment about whether and how much prices are being distorted. Yet, such a small base of experience with relatively new trading vehicles that potentially wield significant influence on behavior (and ultimately prices), at the very least, warrants skepticism and open-minded caution.
What's changed is usually a good place to start in order to understand a problem.
Adam
Related posts:
Michael Masters: Commodities Complex in the Throes of a Bubble
Oil's Endless Bid
Ray Dalio on Stocks & Commodities
Financialization of Copper
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, April 22, 2011
Research in Motion: Contrarian Investment or Trap?
Here's a recent Barron's article on Research in Motion (RIMM) and its troubles.
Research in Motion clearly exists within a very difficult to understand competitive landscape, the rapidly changing smartphone world, but eventually what seems like a low price relative to prospects makes something like this interesting.
It's certainly not the kind of wide moat business in a stable industry that I usually like to invest in. So I won't buy it.*
The extremely low valuations across the big cap tech landscape was hard to imagine a decade ago. As technology companies, each has real competitive threats (some more than others) and other short-to-intermediate term difficulties. Yet, it's hard to understand why many of them seem to be selling at more or less a discount to a conservative estimate of intrinsic value.
Some of the big cap tech stocks now sell at enterprise value (enterprise value = market cap - net cash) to earnings in the low teens while others sell at single digit multiples.
These businesses, to varying degrees, generate more than respectable returns on capital. It's the durability of those economics that is always a difficult question to answer with tech companies. That's why, unless there is a huge discount to intrinsic value, for me it's preferable to avoid them.
Having said that, I could buy the idea that one or two of them are going to get into trouble but...all of them? It's tough to come up with a plausible scenario where that happens. The basic arithmetic of these valuations does not seem to make sense given likely future outcomes. A business selling at a single digit multiple (or normalized earnings) can generate healthy returns for owners even with no growth prospects if management is a good steward of capital. Unfortunately, too many are not. Still, as I said in this previous post, if the external threats are financially catastrophic (i.e. many newspapers in recent years) then almost no price to earnings multiple is low enough.
The current situation with tech stocks appears to be the exact opposite of a decade ago where people were paying nonsensical valuations for wildly optimistic future expectations.
Adam
* No position in RIMM. I don't yet have a good feel for the risks involved in a very challenging business with unpredictable competition. So I remain uncomfortable with RIM's competitive threats.
I do have long positions in some other large cap tech stocks though each is small in size relative to the portfolio. The reason they are not larger positions? Because, in general, technology businesses reside within fast changing, unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until the margin of safety shrinks I'm willing to have some limited exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments.
---
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.
Research in Motion clearly exists within a very difficult to understand competitive landscape, the rapidly changing smartphone world, but eventually what seems like a low price relative to prospects makes something like this interesting.
It's certainly not the kind of wide moat business in a stable industry that I usually like to invest in. So I won't buy it.*
The extremely low valuations across the big cap tech landscape was hard to imagine a decade ago. As technology companies, each has real competitive threats (some more than others) and other short-to-intermediate term difficulties. Yet, it's hard to understand why many of them seem to be selling at more or less a discount to a conservative estimate of intrinsic value.
Some of the big cap tech stocks now sell at enterprise value (enterprise value = market cap - net cash) to earnings in the low teens while others sell at single digit multiples.
These businesses, to varying degrees, generate more than respectable returns on capital. It's the durability of those economics that is always a difficult question to answer with tech companies. That's why, unless there is a huge discount to intrinsic value, for me it's preferable to avoid them.
Having said that, I could buy the idea that one or two of them are going to get into trouble but...all of them? It's tough to come up with a plausible scenario where that happens. The basic arithmetic of these valuations does not seem to make sense given likely future outcomes. A business selling at a single digit multiple (or normalized earnings) can generate healthy returns for owners even with no growth prospects if management is a good steward of capital. Unfortunately, too many are not. Still, as I said in this previous post, if the external threats are financially catastrophic (i.e. many newspapers in recent years) then almost no price to earnings multiple is low enough.
The current situation with tech stocks appears to be the exact opposite of a decade ago where people were paying nonsensical valuations for wildly optimistic future expectations.
Adam
* No position in RIMM. I don't yet have a good feel for the risks involved in a very challenging business with unpredictable competition. So I remain uncomfortable with RIM's competitive threats.
I do have long positions in some other large cap tech stocks though each is small in size relative to the portfolio. The reason they are not larger positions? Because, in general, technology businesses reside within fast changing, unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until the margin of safety shrinks I'm willing to have some limited exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, April 21, 2011
American Express 1Q 2011 Earnings
American Express (AXP) handled just 3.9% of the worldwide purchase transactions last year.
Currently, it is the 4th largest card network by that measure.
#1 Visa (V): 66% of global purchase transactions
#2 Mastercard (MA): 25%
#3 UnionPay (Shanghai-based): 4%
So Visa's and Mastercard's transaction market share dwarfs American Express but they have very different business models and, as a result, the economics are not nearly the same. While having just a fraction of the purchase transactions, AmEx actually produces more revenue and earnings.*
AmEx
2010 Revenues = $ 27.8 billion (net of interest expense)
2010 Earnings = $ 4.06 billion
Visa
2010 Revenues = $ 8.06 billion
2010 Earnings = $ 2.97 billion
So Visa has a fine high margin business but AmEx, with less than 1/15th Visa's transaction market share, somewhat amazingly is able to generate both more revenues and earnings. Their model, one which employs a closed loop network, enables AmEx to produce much more economic value for each transaction.
A typical AmEx customer spends more per transaction and, as a result, ends up with a somewhat greater percentage of payment volume than transaction volume. In fact, AmEx customers spend roughly 3-4 times as much per card as Mastercard and Visa cardholders. Also, AmEx generates more revenue as a percentage of the payment volume -- 2.5 percent and even higher when discount fees, card fees, travel commissions, and other fees are included -- than Visa or Mastercard.
Mastercard and Visa, in fact, get only a fraction of that amount.
These differences, at least in part, explain why AmEx generates so much revenue despite handling a much smaller number of transactions.
They also help to explain why, at least up to now, it has remained a wide moat business.
One downside is AmEx's exposure to credit risk. Visa and Mastercard have none since financial insitutions, the customers they serve, take on that risk. AmEx generated 84% of its revenue from the various fees/commissions and 16% from net interest income in the 1st quarter of 2011. So the company remains very spend-centric while its closed-loop peer Discover (DFS) is more lend-centric.
From the latest quarterly earnings release:
The company's return on average equity (ROE) was 27.9 percent, up from 18.0 percent a year ago.
"Record earnings this quarter reflect credit quality and billed business trends that are among the best we’ve seen," said Kenneth I. Chenault, chairman and chief executive officer, American Express. "Cardmember spending was up 17 percent, with broad-based strength across all our businesses segments. After several years of decline, our lending portfolio leveled off and total revenues grew at the healthiest pace since before the recession."
Prior to the financial crisis, AmEx had peak earnings in 2007 of $ 4.01 billion.
This article in The New York Times has a good summary of its most recent results.
This year, the company's earning power will easily eclipse pre-crisis levels and, while never exactly weak, a much stronger balance sheet.
Adam
Long position in AXP established at much lower prices
* See AmEx's results for the period ending 12/31/10 and Visa's results for the period ending 09/30/10.
---
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.
Currently, it is the 4th largest card network by that measure.
#1 Visa (V): 66% of global purchase transactions
#2 Mastercard (MA): 25%
#3 UnionPay (Shanghai-based): 4%
So Visa's and Mastercard's transaction market share dwarfs American Express but they have very different business models and, as a result, the economics are not nearly the same. While having just a fraction of the purchase transactions, AmEx actually produces more revenue and earnings.*
AmEx
2010 Revenues = $ 27.8 billion (net of interest expense)
2010 Earnings = $ 4.06 billion
Visa
2010 Revenues = $ 8.06 billion
2010 Earnings = $ 2.97 billion
So Visa has a fine high margin business but AmEx, with less than 1/15th Visa's transaction market share, somewhat amazingly is able to generate both more revenues and earnings. Their model, one which employs a closed loop network, enables AmEx to produce much more economic value for each transaction.
A typical AmEx customer spends more per transaction and, as a result, ends up with a somewhat greater percentage of payment volume than transaction volume. In fact, AmEx customers spend roughly 3-4 times as much per card as Mastercard and Visa cardholders. Also, AmEx generates more revenue as a percentage of the payment volume -- 2.5 percent and even higher when discount fees, card fees, travel commissions, and other fees are included -- than Visa or Mastercard.
Mastercard and Visa, in fact, get only a fraction of that amount.
These differences, at least in part, explain why AmEx generates so much revenue despite handling a much smaller number of transactions.
They also help to explain why, at least up to now, it has remained a wide moat business.
One downside is AmEx's exposure to credit risk. Visa and Mastercard have none since financial insitutions, the customers they serve, take on that risk. AmEx generated 84% of its revenue from the various fees/commissions and 16% from net interest income in the 1st quarter of 2011. So the company remains very spend-centric while its closed-loop peer Discover (DFS) is more lend-centric.
From the latest quarterly earnings release:
The company's return on average equity (ROE) was 27.9 percent, up from 18.0 percent a year ago.
"Record earnings this quarter reflect credit quality and billed business trends that are among the best we’ve seen," said Kenneth I. Chenault, chairman and chief executive officer, American Express. "Cardmember spending was up 17 percent, with broad-based strength across all our businesses segments. After several years of decline, our lending portfolio leveled off and total revenues grew at the healthiest pace since before the recession."
Prior to the financial crisis, AmEx had peak earnings in 2007 of $ 4.01 billion.
This article in The New York Times has a good summary of its most recent results.
This year, the company's earning power will easily eclipse pre-crisis levels and, while never exactly weak, a much stronger balance sheet.
Adam
Long position in AXP established at much lower prices
* See AmEx's results for the period ending 12/31/10 and Visa's results for the period ending 09/30/10.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 20, 2011
Buffett on Debt: Berkshire Shareholder Letter Highlights
"Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun." - Warren Buffett in the 1987 Berkshire Hathaway (BRKa) Shareholder Letter
Written over two decades ago, the above quote is not unlike the recent "our elephant gun has been reloaded, and my trigger finger is itchy" comment by Warren Buffett that received plenty of press after the release of the 2010 Berkshire Hathaway shareholder letter.
Though similar, the earlier quote is used in the context of how and when debt should be used to finance acquisitions. From the 1987 Berkshire Hathaway shareholder letter:
"To be sure, it is likely that Berkshire could improve its return on equity by moving to a much higher, though still conventional, debt-to-business-value ratio. It's even more likely that we could handle such a ratio, without problems, under economic conditions far worse than any that have prevailed since the early 1930s.
But we do not wish it to be only likely that we can meet our obligations; we wish that to be certain. Thus we adhere to policies - both in regard to debt and all other matters - that will allow us to achieve acceptable long-term results under extraordinarily adverse conditions, rather than optimal results under a normal range of conditions.
Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity: Our opinions about debt have remained constant.
However, we are not phobic about borrowing. (We're far from believing that there is no fate worse than debt.) We are willing to borrow an amount that we believe - on a worst-case basis - will pose no threat to Berkshire's well-being. Analyzing what that amount might be, we can look to some important strengths that would serve us well if major problems should engulf our economy: Berkshire's earnings come from many diverse and well-entrenched businesses; these businesses seldom require much capital investment; what debt we have is structured well; and we maintain major holdings of liquid assets. Clearly, we could be comfortable with a higher debt-to-business-value ratio than we now have.
One further aspect of our debt policy deserves comment: Unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it. A business obtains the best financial results possible by managing both sides of its balance sheet well. This means obtaining the highest-possible return on assets and the lowest-possible cost on liabilities. It would be convenient if opportunities for intelligent action on both fronts coincided. However, reason tells us that just the opposite is likely to be the case: Tight money conditions, which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side.
Alas, what is 'tight' and 'cheap' money is far from clear at any particular time. We have no ability to forecast interest rates and - maintaining our usual open-minded spirit - believe that no one else can. Therefore, we simply borrow when conditions seem non-oppressive and hope that we will later find intelligent expansion or acquisition opportunities, which - as we have said - are most likely to pop up when conditions in the debt market are clearly oppressive. Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.
Our fund-first, buy-or-expand-later policy almost always penalizes near-term earnings."
So use of debt is fine if it doesn't pose risk to the franchise.
Borrow in anticipation of needs not in reaction to needs.
Obtain debt when borrowing conditions seem loose.
Acquire businesses when borrowing (tight borrowing conditions = fewer competing bidders) becomes tight.
The better banks should be in the process of doing something similar, the difference being that unlike Berkshire they are not in the business of using their liabilities (predominantly deposits) to acquire businesses but instead to acquire profitable loans.
Berkshire Hathaway:
Uses liabilities (insurance float, other sources of borrowing) to acquire assets (profitable businesses).
Banks:
Uses liabilities (predominantly deposits) to acquire assets (loans, bonds etc.).
Some seem disappointed that the loan growth for banks has not begun in earnest. Buffett's model above suggests the smart ones should pursue loan growth more cautiously. While still in the process of cleaning up the junkier balance sheet assets acquired in the last cycle, banks should be focused on borrowing as cheaply as possible* (ie. building a larger base of stable, cheap deposits) now in anticipation of acquiring quality profitable loans later.
I think today's earnings release from Wells Fargo (WFC) is further evidence that loan growth is not going to happen (and shouldn't) just yet. In fact, it might be wise to shrink a bit first (slowly get rid of or burn off the poor quality stuff). The loan growth part of the cycle is still ahead of them and there is no rush.
I'll take slower, profitable growth any day.
Adam
Long BRKb and WFC
* For banks this means acquiring cheap deposits...at least cheap relative to other banks. When short-term rates start to rise so will the cost of deposits for all banks. The key is being able to establish a relatively lower cost deposit base than your competitors. Some banks clearly do this better than others and gain an enormous advantage (ie. higher ROE) over a complete business cycle.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Written over two decades ago, the above quote is not unlike the recent "our elephant gun has been reloaded, and my trigger finger is itchy" comment by Warren Buffett that received plenty of press after the release of the 2010 Berkshire Hathaway shareholder letter.
Though similar, the earlier quote is used in the context of how and when debt should be used to finance acquisitions. From the 1987 Berkshire Hathaway shareholder letter:
"To be sure, it is likely that Berkshire could improve its return on equity by moving to a much higher, though still conventional, debt-to-business-value ratio. It's even more likely that we could handle such a ratio, without problems, under economic conditions far worse than any that have prevailed since the early 1930s.
But we do not wish it to be only likely that we can meet our obligations; we wish that to be certain. Thus we adhere to policies - both in regard to debt and all other matters - that will allow us to achieve acceptable long-term results under extraordinarily adverse conditions, rather than optimal results under a normal range of conditions.
Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity: Our opinions about debt have remained constant.
However, we are not phobic about borrowing. (We're far from believing that there is no fate worse than debt.) We are willing to borrow an amount that we believe - on a worst-case basis - will pose no threat to Berkshire's well-being. Analyzing what that amount might be, we can look to some important strengths that would serve us well if major problems should engulf our economy: Berkshire's earnings come from many diverse and well-entrenched businesses; these businesses seldom require much capital investment; what debt we have is structured well; and we maintain major holdings of liquid assets. Clearly, we could be comfortable with a higher debt-to-business-value ratio than we now have.
One further aspect of our debt policy deserves comment: Unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it. A business obtains the best financial results possible by managing both sides of its balance sheet well. This means obtaining the highest-possible return on assets and the lowest-possible cost on liabilities. It would be convenient if opportunities for intelligent action on both fronts coincided. However, reason tells us that just the opposite is likely to be the case: Tight money conditions, which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side.
Alas, what is 'tight' and 'cheap' money is far from clear at any particular time. We have no ability to forecast interest rates and - maintaining our usual open-minded spirit - believe that no one else can. Therefore, we simply borrow when conditions seem non-oppressive and hope that we will later find intelligent expansion or acquisition opportunities, which - as we have said - are most likely to pop up when conditions in the debt market are clearly oppressive. Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.
Our fund-first, buy-or-expand-later policy almost always penalizes near-term earnings."
So use of debt is fine if it doesn't pose risk to the franchise.
Borrow in anticipation of needs not in reaction to needs.
Obtain debt when borrowing conditions seem loose.
Acquire businesses when borrowing (tight borrowing conditions = fewer competing bidders) becomes tight.
The better banks should be in the process of doing something similar, the difference being that unlike Berkshire they are not in the business of using their liabilities (predominantly deposits) to acquire businesses but instead to acquire profitable loans.
Berkshire Hathaway:
Uses liabilities (insurance float, other sources of borrowing) to acquire assets (profitable businesses).
Banks:
Uses liabilities (predominantly deposits) to acquire assets (loans, bonds etc.).
Some seem disappointed that the loan growth for banks has not begun in earnest. Buffett's model above suggests the smart ones should pursue loan growth more cautiously. While still in the process of cleaning up the junkier balance sheet assets acquired in the last cycle, banks should be focused on borrowing as cheaply as possible* (ie. building a larger base of stable, cheap deposits) now in anticipation of acquiring quality profitable loans later.
I think today's earnings release from Wells Fargo (WFC) is further evidence that loan growth is not going to happen (and shouldn't) just yet. In fact, it might be wise to shrink a bit first (slowly get rid of or burn off the poor quality stuff). The loan growth part of the cycle is still ahead of them and there is no rush.
I'll take slower, profitable growth any day.
Adam
Long BRKb and WFC
* For banks this means acquiring cheap deposits...at least cheap relative to other banks. When short-term rates start to rise so will the cost of deposits for all banks. The key is being able to establish a relatively lower cost deposit base than your competitors. Some banks clearly do this better than others and gain an enormous advantage (ie. higher ROE) over a complete business cycle.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Tuesday, April 19, 2011
Is J&J Turning a Corner?
Johnson & Johnson (JNJ) has certainly had a rough go of it with a string of product recalls. The latest quarterly results won't erase that but the results look like progress.
It's not news that Johnson & Johnson is and has been a cash machine throughout the financial crisis and recent extremely disappointing recall difficulties. The fact that revenue began rising again and earnings came in a bit stronger would seem to be.
"Our pharmaceuticals business demonstrated strong growth this quarter led by the performance of recently launched products. We delivered solid earnings while making the investments necessary to advance the robust pipelines across our businesses," said William C. Weldon, Chairman and Chief Executive Officer.
"The innovations we are bringing to the market, the changes we are implementing in manufacturing and quality, and the dedication of the people of Johnson & Johnson, give us great confidence in the future growth prospects of our business," said Weldon.
Generally, if it's a good business with durable advantages my view is the noise of quarterly earnings makes little sense to expend much energy on. Yet, when a company has been struggling with quality and other issues, quarterly earnings becomes a way to get an indication of progress.
Whether Johnson & Johnson has turned a corner is tough to know. I have no idea. As they work through their serious short-to-intermediate term operational problems, it's a business I continue to want to own even if the stock is likely to be unexciting for an extended period. Others may be interested in trying to time it/wait for some catalyst. That's understandable but carries its own risks. I happen to like the current price relative to current intrinsic value. More importantly, I like the current price relative to the prospects for the business to compound in value over 10 to 20 years.
"I can't recall ever once having seen the name of a market timer on Forbes' annual list of the richest people in the world." - Peter Lynch
Attempting to time it creates the risk of missing it. An error of omission. For some mediocre businesses that'd be okay. Not J&J. It's the kind of business I want to own for a long time once available at a fair price. For me that's around current prices.
If the investing horizon is long, buy when a good business has real but fixable problems that suppress valuations.
At least for me, judging whether price provides a margin of safety relative to estimated intrinsic value is easier than trying to time things correctly. I think getting the timing right is near impossible on a consistent basis. Paying the right price all risks considered is not. For J&J, would rather sit on dead money (or worse) for an extended period to eliminate that risk of missing it at a fair price.
As long as I'm correct in assessing the business's long-term prospects the dividend will, supported by significant free cash flow, offer some compensation for waiting.
"I can't recall ever once having seen the name of a market timer on Forbes' annual list of the richest people in the world." - Peter Lynch
Attempting to time it creates the risk of missing it. An error of omission. For some mediocre businesses that'd be okay. Not J&J. It's the kind of business I want to own for a long time once available at a fair price. For me that's around current prices.
If the investing horizon is long, buy when a good business has real but fixable problems that suppress valuations.
At least for me, judging whether price provides a margin of safety relative to estimated intrinsic value is easier than trying to time things correctly. I think getting the timing right is near impossible on a consistent basis. Paying the right price all risks considered is not. For J&J, would rather sit on dead money (or worse) for an extended period to eliminate that risk of missing it at a fair price.
As long as I'm correct in assessing the business's long-term prospects the dividend will, supported by significant free cash flow, offer some compensation for waiting.
Adam
Have established a long position in JNJ
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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.
Have established a long position in JNJ
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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.
Monday, April 18, 2011
Grantham on Small Cap Stocks
I don't often find forecasts to be all that useful, but GMO's 7-year forecasts* for certain asset classes hasn't been a bad way to gauge which assets might be generally overvalued/undervalued. Ultimately, at least for myself, it still comes down to finding good individual businesses that are cheap.
GMO's Jeremy Grantham's latest warning is to watch out for small caps. In this MarketWatch article, he makes the following points:
- Small-cap stocks will do poorly. They'll likely lose something like a fifth their value in real terms over the next seven years.
- Buying assets when they are expensive in the hope of selling them at a higher price is basically just gambling.
GMO' currently has U.S. High Quality and Managed Timber performing relatively well though still lower than U.S. historic equity returns.
It's worth noting that GMO's forecasts are made on a real basis. Their recent long-term inflation assumption has been 2.5 percent. That's where owning higher quality businesses might be a big advantage. An enterprise with sustainable competitive advantages and pricing power offer some protection against what might be a more challenging than expected inflation environment.
Adam
* Here's an example of GMO's 7-year forecasts for certain asset classes as of December 31, 2010. Their more recent forecasts can be viewed on GMO's website (registration required).
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.
GMO's Jeremy Grantham's latest warning is to watch out for small caps. In this MarketWatch article, he makes the following points:
- Small-cap stocks will do poorly. They'll likely lose something like a fifth their value in real terms over the next seven years.
- Buying assets when they are expensive in the hope of selling them at a higher price is basically just gambling.
GMO' currently has U.S. High Quality and Managed Timber performing relatively well though still lower than U.S. historic equity returns.
It's worth noting that GMO's forecasts are made on a real basis. Their recent long-term inflation assumption has been 2.5 percent. That's where owning higher quality businesses might be a big advantage. An enterprise with sustainable competitive advantages and pricing power offer some protection against what might be a more challenging than expected inflation environment.
Adam
* Here's an example of GMO's 7-year forecasts for certain asset classes as of December 31, 2010. Their more recent forecasts can be viewed on GMO's website (registration required).
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, April 15, 2011
A Look at Big Cap Tech Valuations
Check out the market value and multiples of earnings of the following stocks in 2001 (these are not peak valuations by any means...the bubble had already burst) compared to 2010:
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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.
2001
Stock |Market Value| Earnings
AAPL | $ 5.3 billion |$-25 million
DELL | $ 74 billion |$ 1.2 billion
MSFT |$ 401 billion |$ 7.3 billion
CSCO |$ 138 billion |$-1.0 billion
Total |$ 618 billion |$ 7.5 billion
2010
Stock | Market Value| Earnings
AAPL|$ 307 billion | $14.0 billion
DELL | $ 29 billion | $ 2.6 billion
MSFT| $ 225 billion |$18.8 billion
CSCO | $ 97 billion | $ 7.8 billion
Total | $ 658 billion | $43.2 billion
So the earning power compared to market capitalization for these tech stocks has dropped meaningfully over the past decade or so.
Some things for consideration:
Even though Apple's explosive growth is remarkable, it's worth noting that none of the above businesses have exactly suffered financially in the past decade. Look beyond the headlines (there are obviously some very real threats) and it's clear that each has materially higher earning power now than they did a decade ago.
For Microsoft, Cisco, and Dell the lousy returns has not been driven by poor business performance over that time. It's that their stock prices made no sense back then. So business performance didn't cause lousy shareholder returns...it was the prices paid relative to approximate intrinsic value. Too much being paid for an overly optimistic future. I suspect the same will turn out to be true for many of today's high flyers (and I'm not talking about Apple, it has been an incredible stock but still seems not that expensive adjusted for net cash and expected 2011 earnings).
Again, the 2001 numbers are post-bubble market prices. All of the above firms were well off their bubble highs by 2001 so valuations looked even worse a year earlier (Cisco's market value alone hovered around $ 600 billion during the the bubble).
As a result of inventory write-downs, Cisco's earnings were well below normalized in 2001 and quickly rebounded. The following year the company earned $ 1.9 billion giving it a price to forward earnings multiple of 71x. Not exactly cheap.
Today, most of the above companies have enormous amounts of net cash relative to current market value. Apple and Cisco have north of 20% of market value in cash while Dell's pile of cash is approaching 30% of its market value. Combined the above companies today have more than $ 120 billion of net cash.
The earnings of the above five companies should be well north of $ 60 billion this year. Back out the cash on the balance sheet from the $ 753 billion market value and you get a combined enterprise value = $ 633 billion. So $ 633 billion buys around $ 60 billion of 2011 earning power or a 10.5x multiple.
A little over a decade ago the future of these businesses looked great (other than Apple, ironically) and prices more than reflected that. If you pay up for an extremely rosy future and it doesn't come to be you lose money. Now it seems the prices of some large cap tech stocks are getting closer to more or less reflecting expected difficulties and other unknowns. None of this is easy to judge considering how fast things change in the world of technology. I say that generally not being a fan of tech stocks. In fact, there's just no technology business that I'm comfortable with as a long-term investment.*
Still, eventually the price gets low enough to provide a more than adequate margin of safety.
What happens when you pay a price that reflects a lousy expected future and even a decent one comes to be?
Not much has to go right** when an investor has a long time horizon and the stock of a decent business (i.e. return on capital may not match the best but must be respectable...so no airlines or automakers) approaches single digit price to earnings. If the external threats are financially catastrophic (i.e. most newspapers in recent years) then almost no price to earnings multiple is low enough. If an investor believes this is the future for some of the above stocks then it makes sense to avoid them.
It's always possible one of these businesses experiencing real trouble now will catch a wave down the road. Just better to not pay up front for that possibility. Instead, pay a price where even a mediocre future outcome will produce satisfactory returns. If the business happens to catch an unforeseen wave that'll be a bonus.
Adam
* Long positions in the stocks mentioned above. These are likely will remain mostly not very large positions. May consider making additional purchases if/when there are further price declines and margin of safety is sufficient. (DELL is by far the smallest position and, for several reasons, requires the largest margin of safety in my view.) The reason these are not larger positions? Because, in general, technology businesses reside in fast changing and unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until that margin of safety shrinks I'm willing to have some limited exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments. Occasionally, some have sold at enough of a discount to be worth the trouble but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries. That's precisely what makes them unattractive long-term investments.
** If a stock gets into single digit price to earnings multiples, even an earnings stream that shrinks by 20% over 10 years then stabilizes will produce a 6-7% annual returns over ten years as long as the CEO isn't throwing the free cash flow into a furnace. That's nothing great as far as returns go but it's meant as a simple way to gauge downside risk. Some assume a shrinking earnings stream always results in shrinking long-term valuation. That's not the case if the stock is bought at the right price and the earnings in fact do stabilize at that lower level. Possibly somewhat counterintuitive but true. It takes very simple spreadsheet analysis to verify the math on this. Now, if an investor believes the earnings stream will persistently decline or their will be a catastrophic permanent drop in earnings that's another story.2010
Stock | Market Value| Earnings
AAPL|$ 307 billion | $14.0 billion
DELL | $ 29 billion | $ 2.6 billion
MSFT| $ 225 billion |$18.8 billion
CSCO | $ 97 billion | $ 7.8 billion
Total | $ 658 billion | $43.2 billion
So the earning power compared to market capitalization for these tech stocks has dropped meaningfully over the past decade or so.
Some things for consideration:
Even though Apple's explosive growth is remarkable, it's worth noting that none of the above businesses have exactly suffered financially in the past decade. Look beyond the headlines (there are obviously some very real threats) and it's clear that each has materially higher earning power now than they did a decade ago.
For Microsoft, Cisco, and Dell the lousy returns has not been driven by poor business performance over that time. It's that their stock prices made no sense back then. So business performance didn't cause lousy shareholder returns...it was the prices paid relative to approximate intrinsic value. Too much being paid for an overly optimistic future. I suspect the same will turn out to be true for many of today's high flyers (and I'm not talking about Apple, it has been an incredible stock but still seems not that expensive adjusted for net cash and expected 2011 earnings).
Again, the 2001 numbers are post-bubble market prices. All of the above firms were well off their bubble highs by 2001 so valuations looked even worse a year earlier (Cisco's market value alone hovered around $ 600 billion during the the bubble).
As a result of inventory write-downs, Cisco's earnings were well below normalized in 2001 and quickly rebounded. The following year the company earned $ 1.9 billion giving it a price to forward earnings multiple of 71x. Not exactly cheap.
Today, most of the above companies have enormous amounts of net cash relative to current market value. Apple and Cisco have north of 20% of market value in cash while Dell's pile of cash is approaching 30% of its market value. Combined the above companies today have more than $ 120 billion of net cash.
The earnings of the above five companies should be well north of $ 60 billion this year. Back out the cash on the balance sheet from the $ 753 billion market value and you get a combined enterprise value = $ 633 billion. So $ 633 billion buys around $ 60 billion of 2011 earning power or a 10.5x multiple.
A little over a decade ago the future of these businesses looked great (other than Apple, ironically) and prices more than reflected that. If you pay up for an extremely rosy future and it doesn't come to be you lose money. Now it seems the prices of some large cap tech stocks are getting closer to more or less reflecting expected difficulties and other unknowns. None of this is easy to judge considering how fast things change in the world of technology. I say that generally not being a fan of tech stocks. In fact, there's just no technology business that I'm comfortable with as a long-term investment.*
Still, eventually the price gets low enough to provide a more than adequate margin of safety.
What happens when you pay a price that reflects a lousy expected future and even a decent one comes to be?
Not much has to go right** when an investor has a long time horizon and the stock of a decent business (i.e. return on capital may not match the best but must be respectable...so no airlines or automakers) approaches single digit price to earnings. If the external threats are financially catastrophic (i.e. most newspapers in recent years) then almost no price to earnings multiple is low enough. If an investor believes this is the future for some of the above stocks then it makes sense to avoid them.
It's always possible one of these businesses experiencing real trouble now will catch a wave down the road. Just better to not pay up front for that possibility. Instead, pay a price where even a mediocre future outcome will produce satisfactory returns. If the business happens to catch an unforeseen wave that'll be a bonus.
Adam
* Long positions in the stocks mentioned above. These are likely will remain mostly not very large positions. May consider making additional purchases if/when there are further price declines and margin of safety is sufficient. (DELL is by far the smallest position and, for several reasons, requires the largest margin of safety in my view.) The reason these are not larger positions? Because, in general, technology businesses reside in fast changing and unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until that margin of safety shrinks I'm willing to have some limited exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments. Occasionally, some have sold at enough of a discount to be worth the trouble but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries. That's precisely what makes them unattractive long-term investments.
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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.
Thursday, April 14, 2011
The Currency Casino
Gain Capital Holdings (GCAP) and FXCM (FXCM) are providers of retail foreign-exchange services and completed initial public offerings late last year. Check out this Barron's article on the lightly regulated world of foreign-exchange trading. Apparently, 50-to-1 leverage is allowed for some participants.
The article makes the point that those who open one of these trading accounts...
...don't be surprised if you depart from it with a lighter wallet.
The article makes the point that those who open one of these trading accounts...
...don't be surprised if you depart from it with a lighter wallet.
Roughly three-quarters of individual investors who trade through forex firms like Gain Capital Holdings lose money, resulting in an estimated client-attrition rate of 15% to 25% a year, versus less than 5% at online stockbrokers.
How about using leverage to gain more leverage? Apparently some customer deposits are funded with credit cards.
Hey, at least the CFTC (Commodities Futures Trading Commission) lowered the leverage limit. They actually lowered the leverage limit from 100-to-1.
So 50-to-1 is somehow supposed to represent low leverage? If something is being bought with leverage in the form of a credit card to begin with I'm not sure how lowering the leverage limit from 100-to-1 to 50-to-1 has any real meaning. Maybe it does.
In any case, sure makes attempting to buy shares in boring but stable businesses at the right price, and for the longer haul, look pretty tame.*
Personally, if I couldn't find a plane and needed to get across the ocean I'd take a ship. The above seems the equivalent of attempting to get across on the back of a sailfish.**
To any regular reader of this blog, it's obvious that the primary focus here has been to find and own shares of good businesses* (that happen to be public companies for convenience) with an indefinite but ideally "forever" holding period. If you get it right, the core economics of each business itself does the heavy lifting over time when it comes to producing returns. No leverage.
None.
I'm guessing anyone intrigued by highly leveraged forex trading will find the main focus of this blog, well, boring.
Find good businesses; buy shares at a discount to value; minimize...
Uh, never mind.
Adam
No position in stocks mentioned
No position in stocks mentioned
* Tame, but not necessarily easy. The tough part is figuring out things like: What's the estimated per share intrinsic value? Is there a sufficient enough discount to that value available at prevailing market prices? How durable are today's competitive advantages? Not exactly stuff that's always clear.
** Apparently, the sailfish can hit 68 mph for shorter periods of time. That is quicker than any other fish. So someone could, at least theoretically, get to their destination more quickly than on a ship. Obviously, that doesn't make it a brilliant alternative means of transport.
---** Apparently, the sailfish can hit 68 mph for shorter periods of time. That is quicker than any other fish. So someone could, at least theoretically, get to their destination more quickly than on a ship. Obviously, that doesn't make it a brilliant alternative means of transport.
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 13, 2011
Michael Masters: Commodities Complex in the Throes of a Bubble
Michael Masters was interviewed by Maria Bartiromo on CNBC yesterday. Below are some excerpts of his thoughts on oil prices and commodities in general.
Maria started by pointing out that a number of executives and others in the oil sector have been on recently saying that there is plenty of supply. She asked Masters if he agreed:
"...while people can talk about supply and demand the overriding role is the force of money from financial participants."
What should be done? What new rules? Masters said provide limits to speculation at a specific aggregate level (something like 1/3 speculators, 2/3 bonafide hedgers) and limit commodity index funds. He went on to say...
"...we need speculators to provide liquidity in commodities markets, we don't want them to overwhelm these markets and effect price discovery."
How do you prevent them from overwhelming the markets? According to him it's position limits:
"...the nice thing about position limits is, they worked for 50 years. From the 1930s until the mid-90s. They worked great to limit speculation and to allow enough liquidity in the markets to benefit the hedgers, the primary constituency."
His thoughts on other commodities...
"...the whole commodities complex is really in the throes of a bubble or an echo bubble if you will."
Enormous speculative capital is involved. Masters recently founded Better Markets Inc., a nonprofit focused on the public interest when it comes to commodities prices.
Last week another veteran oil trader, David Greenberg, had the following to say about the oil market on CNBC. Some excerpts:
"The speculators have just taken control of this market, and it's just out of control."
"With the amount of money that is in this market, the market is too small to handle it, so it's very easy for any fund that needs a position to go one way or another to slam it with the algorithms and that's what's moving the market right now."
"The bottom line is there is no disruption of oil right now."
"As far as what can be done to help the oil prices...and that's position limits that nobody seems to ever talk about."
"...in the old days, intraday, there was really barely any intraday margin. Now, on a $ 50,000, you know, crude position, could you probably trade hundreds of thousands of dollars worth. Maybe $1 million worth depending on the day and the position."
Greenberg does point out that the sheer size of the oil market makes it such that position limits alone will probably not fix the problem.
So add the above comments from Masters and Greenberg to these recent comments by another veteran trader, Daniel Dicker, and that's three different sources saying essentially the same thing. If even partially true seems foolish to not address this yesterday.
A sustained distortion in prices will drive investments that later turn out to be a widespread misallocation of resources.
We've seen this movie.
Adam
Related posts:
Oil's Endless Bid
Ray Dalio on Stocks & Commodities
Financialization of Copper
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.
Maria started by pointing out that a number of executives and others in the oil sector have been on recently saying that there is plenty of supply. She asked Masters if he agreed:
"...while people can talk about supply and demand the overriding role is the force of money from financial participants."
What should be done? What new rules? Masters said provide limits to speculation at a specific aggregate level (something like 1/3 speculators, 2/3 bonafide hedgers) and limit commodity index funds. He went on to say...
"...we need speculators to provide liquidity in commodities markets, we don't want them to overwhelm these markets and effect price discovery."
How do you prevent them from overwhelming the markets? According to him it's position limits:
"...the nice thing about position limits is, they worked for 50 years. From the 1930s until the mid-90s. They worked great to limit speculation and to allow enough liquidity in the markets to benefit the hedgers, the primary constituency."
His thoughts on other commodities...
"...the whole commodities complex is really in the throes of a bubble or an echo bubble if you will."
Enormous speculative capital is involved. Masters recently founded Better Markets Inc., a nonprofit focused on the public interest when it comes to commodities prices.
Last week another veteran oil trader, David Greenberg, had the following to say about the oil market on CNBC. Some excerpts:
"The speculators have just taken control of this market, and it's just out of control."
"With the amount of money that is in this market, the market is too small to handle it, so it's very easy for any fund that needs a position to go one way or another to slam it with the algorithms and that's what's moving the market right now."
"The bottom line is there is no disruption of oil right now."
"As far as what can be done to help the oil prices...and that's position limits that nobody seems to ever talk about."
"...in the old days, intraday, there was really barely any intraday margin. Now, on a $ 50,000, you know, crude position, could you probably trade hundreds of thousands of dollars worth. Maybe $1 million worth depending on the day and the position."
Greenberg does point out that the sheer size of the oil market makes it such that position limits alone will probably not fix the problem.
So add the above comments from Masters and Greenberg to these recent comments by another veteran trader, Daniel Dicker, and that's three different sources saying essentially the same thing. If even partially true seems foolish to not address this yesterday.
A sustained distortion in prices will drive investments that later turn out to be a widespread misallocation of resources.
We've seen this movie.
Adam
Related posts:
Oil's Endless Bid
Ray Dalio on Stocks & Commodities
Financialization of Copper
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, April 12, 2011
Six Stock Portfolio Update
Portfolio performance since mentioning on April 9, 2009 that I like these six stocks as long-term investments if bought near prevailing prices at that time (or lower, of course).
While I never make stock recommendations each of these, at the right price, are what I consider attractive long-term investments for my own capital.
The portfolio is made up of the following stocks: Wells Fargo (WFC), Diageo (DEO), Philip Morris International (PM, Pepsi (PEP), Lowe's (LOW), and American Express (AXP).
Stock |Total Return*
WFC | 70.9%
DEO | 83.0%
PM | 90.2%
PEP | 33.4%
LOW | 37.6%
AXP | 172.4%
Total return for the six stocks combined is 81.2% (including dividends) since April 9th, 2009 while the S&P 500 is up 63.2% (also including dividends) over that same time frame. This is a conservative calculation of returns based upon the average price of each security on the date mentioned. Better market prices were available in subsequent days so total returns could have been improved with some careful accumulation.
The above is a relatively low turnover and concentrated portfolio of high quality businesses. It is, in part, meant to be an example of Newton's 4th Law at work (or, alternatively, a way to avoid being tripped by the invisible foot).
Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy. - Warren Buffett in the 1983 Berkshire Hathaway Annual (BRKa) Shareholder Letter
The approach rejects the idea that trading rapidly in and out of different securities is necessary to create above average returns. Instead, build a stable/concentrated portfolio of high quality businesses that can outperform over the long-haul.
Buying shares at a discount to value (conservatively calculated), low "frictional costs", and the intrinsic value created by the businesses themselves becomes the driver of total returns not some special aptitude for trading or timing the market. In short, the outperformance, if it continues, will come from owning shares of good businesses bought with an appropriate margin of safety combined with little in the way of unnecessary fees, commissions, and related costs.
Buffett on Helpers and "Frictional" Costs
Many equity investors would get improved long-term returns, at lower risk, if they: 1) bought (at fair or better prices) shares in 5-10 great businesses, 2) avoided the hyperactive trading ethos that is so popular these days to minimize mistakes & frictional costs, and 3) sold shares in these businesses only if the core long-term economics become impaired or opportunity costs are extremely high.
This six stock portfolio is clearly very concentrated by most standards but the Buffett/Munger approach rejects the idea that vast diversification is needed.
I have more than skepticism regarding the orthodox view that huge diversification is a must for those wise enough so that indexation is not the logical mode for equity investment. I think the orthodox view is grossly mistaken.
In the United States, a person or institution with almost all wealth invested, long term, in just three fine domestic corporations is securely rich. And why should such an owner care if at any time most other investors are faring somewhat better or worse. And particularly so when he rationally believes, like Berkshire, that his long-term results will be superior by reason of his lower costs, required emphasis on long-term effects, and concentration in his most preferred choices. - Charlie Munger in this 1998 speech to the Foundation Financial Officers Group
Clearly some, depending on background and experience, may need to diversify holdings a bit more. For others, low expense index funds may make more sense than buying individual stocks. Yet, keeping trading and other frictional costs to a minimum is almost always wise.
As always, one of the most important things is to always stay well within one's own limits as an investor.
Though I could surely be wrong, I consider these six stocks appropriate for my own portfolio (not someone else's) given my understanding of the downside risks and potential rewards. It doesn't make sense for others unless they do their own research and reach similar conclusions.
The above concentrated portfolio of six stocks obviously won't outperform in every period. In the long run, it has a reasonable probability of doing well compared to the S&P 500 due to lower frictional costs and the durable high return qualities of the businesses. While unlikely to outperform the very best portfolio managers**, it's likely to perform well on a risk-adjusted basis relative to the market as a whole over a period of 10 years+.
It's also worth noting the unusual allocation of this portfolio. First of all, there is not/has not been exposure to the hot sectors (commodities these days and surely something else down the road) and no attempt to do so. When I put this together, I intentionally allocated one half the portfolio to consumer staples (DEO, PEP, PM), a third in financials (WFC, AXP), and a housing stock (LOW). At the time, none of these were exactly the hot trade of the moment. Staples too defensive. Financials and housing a mess. All partly true but shares of a good businesses usually aren't cheap when the macro environment looks great.
Not to beat a dead horse but most readers of this blog will know the one thing I've said consistently is that the Coca-Cola's, Pepsi's, and Philip Morris International's of the world are not defensive in the long-run. They are often a lower risk way to outperform.
(Okay, maybe I've beaten this one dead but the best consumer staple businesses, while each having a unique set of risks, often do not get enough respect as long-term offense instead getting overplayed as short-term defense.)
The point is I wanted this portfolio to be made up of businesses that, once shares were bought at the right price, could be, for the most part, left alone to compound in value across multiple business cycles. Some may want exposure to other sectors not represented here which is fine if quality can be had at a fair price. We'll see how it continues to perform.
In any case, this simple example is designed so it's easy for anyone to check the results over time using this blog. If this six stock portfolio*** isn't performing well against the S&P 500 it will be obvious. The idea that a concentrated portfolio of quality businesses can perform well while avoiding the hassle and risks of trading should, at least, be of some interest. Producing results via the increasingly popular hyperactive buying and selling of securities seems inspired by Sisyphus by comparison to me.
Finally, an opportunity may come along where the capital from one of these stocks is needed. My view is under such a scenario the threshold for making changes needs to be high. That hypothetical new investment must have clearly superior economics and relative price.
In addition, if something appears to fundamentally threaten the moat (ie. the effect of the internet on the newspaper biz) of one of these businesses a change may also be warranted.
So I may rarely add or switch some of the stocks in this portfolio but I will only make a change if the situation described above exists (ie. if the core long-term economics of one of these stocks become impaired or opportunity costs of not making a change is extremely high).
Keep in mind that even though the stocks I chose have done well versus the S&P 500 I don't consider a mere couple of years as a meaningfully long enough time frame to measure performance.
Adam
Long position in DEO, AXP, PEP, PM, WFC, and LOW
* As of 4/11/11.
** There's no shortage of evidence that many actively managed equity mutual funds underperform the S&P 500.
"Of the 355 equity funds in 1970, fully 233 of those funds--almost two thirds--have gone out of business. Only 24 outpaced the market by more than one percentage point a year--one out of every 14. Let's face it: These are terrible odds!." - John Bogle
Also, DALBAR's Quantitative Analysis of Investor Behavior (QAIB) study released in March 2009 revealed that over the past 20 years investors in stock mutual funds have underperformed the S&P 500 by 6.5% a year (8.35% vs. 1.87%). Beyond the performance of the funds themselves, it shows that much of these poor returns come down to investor behavior. The tendency of investors to buy the hot mutual fund that has been going up while selling when the market is going down out of panic or fear.
*** I don't think these are necessarily the six best businesses in the world, but I believe they are all very good businesses that were selling at reasonable prices on April 9th, 2009. At any moment, there is always something better to own in theory but I don't think you can invest that way (as if stocks are baseball cards) and have consistent success. So there are certainly quite a few other shares in businesses that would be good alternatives to these 6. The point is to get a handful of them at a fair price and then let time work.
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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 are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
While I never make stock recommendations each of these, at the right price, are what I consider attractive long-term investments for my own capital.
The portfolio is made up of the following stocks: Wells Fargo (WFC), Diageo (DEO), Philip Morris International (PM, Pepsi (PEP), Lowe's (LOW), and American Express (AXP).
Stock |Total Return*
WFC | 70.9%
DEO | 83.0%
PM | 90.2%
PEP | 33.4%
LOW | 37.6%
AXP | 172.4%
Total return for the six stocks combined is 81.2% (including dividends) since April 9th, 2009 while the S&P 500 is up 63.2% (also including dividends) over that same time frame. This is a conservative calculation of returns based upon the average price of each security on the date mentioned. Better market prices were available in subsequent days so total returns could have been improved with some careful accumulation.
The above is a relatively low turnover and concentrated portfolio of high quality businesses. It is, in part, meant to be an example of Newton's 4th Law at work (or, alternatively, a way to avoid being tripped by the invisible foot).
Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy. - Warren Buffett in the 1983 Berkshire Hathaway Annual (BRKa) Shareholder Letter
The approach rejects the idea that trading rapidly in and out of different securities is necessary to create above average returns. Instead, build a stable/concentrated portfolio of high quality businesses that can outperform over the long-haul.
Buying shares at a discount to value (conservatively calculated), low "frictional costs", and the intrinsic value created by the businesses themselves becomes the driver of total returns not some special aptitude for trading or timing the market. In short, the outperformance, if it continues, will come from owning shares of good businesses bought with an appropriate margin of safety combined with little in the way of unnecessary fees, commissions, and related costs.
Buffett on Helpers and "Frictional" Costs
Many equity investors would get improved long-term returns, at lower risk, if they: 1) bought (at fair or better prices) shares in 5-10 great businesses, 2) avoided the hyperactive trading ethos that is so popular these days to minimize mistakes & frictional costs, and 3) sold shares in these businesses only if the core long-term economics become impaired or opportunity costs are extremely high.
This six stock portfolio is clearly very concentrated by most standards but the Buffett/Munger approach rejects the idea that vast diversification is needed.
I have more than skepticism regarding the orthodox view that huge diversification is a must for those wise enough so that indexation is not the logical mode for equity investment. I think the orthodox view is grossly mistaken.
In the United States, a person or institution with almost all wealth invested, long term, in just three fine domestic corporations is securely rich. And why should such an owner care if at any time most other investors are faring somewhat better or worse. And particularly so when he rationally believes, like Berkshire, that his long-term results will be superior by reason of his lower costs, required emphasis on long-term effects, and concentration in his most preferred choices. - Charlie Munger in this 1998 speech to the Foundation Financial Officers Group
Clearly some, depending on background and experience, may need to diversify holdings a bit more. For others, low expense index funds may make more sense than buying individual stocks. Yet, keeping trading and other frictional costs to a minimum is almost always wise.
As always, one of the most important things is to always stay well within one's own limits as an investor.
Though I could surely be wrong, I consider these six stocks appropriate for my own portfolio (not someone else's) given my understanding of the downside risks and potential rewards. It doesn't make sense for others unless they do their own research and reach similar conclusions.
The above concentrated portfolio of six stocks obviously won't outperform in every period. In the long run, it has a reasonable probability of doing well compared to the S&P 500 due to lower frictional costs and the durable high return qualities of the businesses. While unlikely to outperform the very best portfolio managers**, it's likely to perform well on a risk-adjusted basis relative to the market as a whole over a period of 10 years+.
It's also worth noting the unusual allocation of this portfolio. First of all, there is not/has not been exposure to the hot sectors (commodities these days and surely something else down the road) and no attempt to do so. When I put this together, I intentionally allocated one half the portfolio to consumer staples (DEO, PEP, PM), a third in financials (WFC, AXP), and a housing stock (LOW). At the time, none of these were exactly the hot trade of the moment. Staples too defensive. Financials and housing a mess. All partly true but shares of a good businesses usually aren't cheap when the macro environment looks great.
Not to beat a dead horse but most readers of this blog will know the one thing I've said consistently is that the Coca-Cola's, Pepsi's, and Philip Morris International's of the world are not defensive in the long-run. They are often a lower risk way to outperform.
(Okay, maybe I've beaten this one dead but the best consumer staple businesses, while each having a unique set of risks, often do not get enough respect as long-term offense instead getting overplayed as short-term defense.)
The point is I wanted this portfolio to be made up of businesses that, once shares were bought at the right price, could be, for the most part, left alone to compound in value across multiple business cycles. Some may want exposure to other sectors not represented here which is fine if quality can be had at a fair price. We'll see how it continues to perform.
In any case, this simple example is designed so it's easy for anyone to check the results over time using this blog. If this six stock portfolio*** isn't performing well against the S&P 500 it will be obvious. The idea that a concentrated portfolio of quality businesses can perform well while avoiding the hassle and risks of trading should, at least, be of some interest. Producing results via the increasingly popular hyperactive buying and selling of securities seems inspired by Sisyphus by comparison to me.
Finally, an opportunity may come along where the capital from one of these stocks is needed. My view is under such a scenario the threshold for making changes needs to be high. That hypothetical new investment must have clearly superior economics and relative price.
In addition, if something appears to fundamentally threaten the moat (ie. the effect of the internet on the newspaper biz) of one of these businesses a change may also be warranted.
So I may rarely add or switch some of the stocks in this portfolio but I will only make a change if the situation described above exists (ie. if the core long-term economics of one of these stocks become impaired or opportunity costs of not making a change is extremely high).
Keep in mind that even though the stocks I chose have done well versus the S&P 500 I don't consider a mere couple of years as a meaningfully long enough time frame to measure performance.
Adam
Long position in DEO, AXP, PEP, PM, WFC, and LOW
* As of 4/11/11.
** There's no shortage of evidence that many actively managed equity mutual funds underperform the S&P 500.
"Of the 355 equity funds in 1970, fully 233 of those funds--almost two thirds--have gone out of business. Only 24 outpaced the market by more than one percentage point a year--one out of every 14. Let's face it: These are terrible odds!." - John Bogle
Also, DALBAR's Quantitative Analysis of Investor Behavior (QAIB) study released in March 2009 revealed that over the past 20 years investors in stock mutual funds have underperformed the S&P 500 by 6.5% a year (8.35% vs. 1.87%). Beyond the performance of the funds themselves, it shows that much of these poor returns come down to investor behavior. The tendency of investors to buy the hot mutual fund that has been going up while selling when the market is going down out of panic or fear.
*** I don't think these are necessarily the six best businesses in the world, but I believe they are all very good businesses that were selling at reasonable prices on April 9th, 2009. At any moment, there is always something better to own in theory but I don't think you can invest that way (as if stocks are baseball cards) and have consistent success. So there are certainly quite a few other shares in businesses that would be good alternatives to these 6. The point is to get a handful of them at a fair price and then let time work.
---------
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
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