Some excerpts from an interview with Charlie Munger in the spring 2009 edition of the Stanford Lawyer:
On Unlimited Leverage
"When the regulators put in the option exchanges, there was just one letter in opposition saying 'you shouldn't do this,' and Warren Buffett wrote it. When they wanted to make the securities market function better as a gambling casino with vast profits for the people who were croupiers—there was a big constituency in favor of dumb change. Buffett was like a man trying to stop an elephant with a pea shooter. We're not controlling financial leverage if we have option exchanges. So these changes repealed longtime control of margin credit by the Federal Reserve System."
"Unlimited leverage comes automatically with an option exchange. Then, next, derivative trading made the option exchange look like a benign event. So just one after another the very people who should have been preventing these asininities were instead allowing foolish departures from the corrective devices we'd put in the last time we had a big trouble—devices that worked quite well."
"Our regulators allowed the proprietary trading departments at investment banks to become hedge funds in disguise, using the 'repo' system—one of the most extreme credit-granting systems ever devised. The amount of leverage was utterly awesome."
On Bringing Back the 'Bucket Shop'
"Interest rate swaps have enormous dangers given their size and the accounting that has been allowed. But credit default derivatives took that danger to new levels of excess—from something that was already gross and wrong. In the '20s we had the 'bucket shop.' The term bucket shop was a term of derision, because it described a gambling parlor. The bucket shop didn't buy any securities. It just enabled people to make bets against the house and the house furnished little statements of how the bets came out. It was like the off-track betting system."
"Derivatives trading, with no central clearing, brought back the bucket shop, because you could make bets without having any interest in the basic security, and people did make such bets in the billions and billions of dollars. Some of the most admired people in finance — including Alan Greenspan — argued that derivatives trading, substituting for the old bucket shop, was a great contribution to modern economic civilization. There's another word for this: bonkers. It is not a credit to academic economics that Greenspan's view was so common."
The complete interview, from back in spring 2009, is definitely well worth reading. There are some excellent insights and, as always, Munger's manner of speaking is no-nonsense.
Munger's emphasis has always been on an interdisciplinary education and that becomes obvious the more you read and listen to him. He started as a student of math and physics before getting a law degree and starting his law firm Munger, Tolles, & Olson.
Then, of course, came his business career.
He's also self-taught on a whole range of subjects some that he can often explain better and in a whole lot more useful manner than what you'll find in academia.
Adam
Related post:
Buffett on Derivatives
Friday, July 29, 2011
Thursday, July 28, 2011
Groupon's Financial Gymnastics
Excerpts from this Wall Street Journal article on Groupon's practices leading up to its initial public offering:
Groupon's Accounting Lingo Gets Scrutiny
Newfangled Accounting Metric
Groupon Inc. has attracted scrutiny from regulators over a newfangled accounting metric...
Dot-Com Boom Redux?
The financial gymnastics harken back to Silicon Valley's late 1990s dot-com boom...
Adjusted CSOI
Groupon...has highlighted in regulatory filings something it calls "adjusted consolidated segment operating income," or adjusted CSOI. Investors and analysts said that draws attention away from marketing costs, which are causing the company to hemorrhage money.
Adjusted CSOI?
That's certainly bold and imaginative if nothing else. Not exactly a compliment when you are talking about accounting.
This company cannot be serious about selling that kind of metric to investors.
In the article, portfolio manager Ben Strubel said it best:
"In essence Groupon is asking investors to look at their profit before any expenses..."
I've said in previous posts it's best to own companies that foster a conservative accounting culture. I don't think Groupon is going to meet that criteria.
This reminds me of the late 1990s more than anything else I've seen lately but, even if there are some specific excesses, we seem a long way from a more generalized problem.
Well, at least so far that is.
Maybe not as enthusiastically at current prices, but I'll stick with the Google's (GOOG) and Apple's (AAPL) of the world. Both are also growing plenty fast and produce exceptional returns on capital.
Highly profitable, real businesses, with fortress balance sheets.
No accounting gimmicks required.
Adam
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Groupon's Accounting Lingo Gets Scrutiny
Newfangled Accounting Metric
Groupon Inc. has attracted scrutiny from regulators over a newfangled accounting metric...
Dot-Com Boom Redux?
The financial gymnastics harken back to Silicon Valley's late 1990s dot-com boom...
Adjusted CSOI
Groupon...has highlighted in regulatory filings something it calls "adjusted consolidated segment operating income," or adjusted CSOI. Investors and analysts said that draws attention away from marketing costs, which are causing the company to hemorrhage money.
Adjusted CSOI?
That's certainly bold and imaginative if nothing else. Not exactly a compliment when you are talking about accounting.
This company cannot be serious about selling that kind of metric to investors.
In the article, portfolio manager Ben Strubel said it best:
"In essence Groupon is asking investors to look at their profit before any expenses..."
I've said in previous posts it's best to own companies that foster a conservative accounting culture. I don't think Groupon is going to meet that criteria.
This reminds me of the late 1990s more than anything else I've seen lately but, even if there are some specific excesses, we seem a long way from a more generalized problem.
Well, at least so far that is.
Maybe not as enthusiastically at current prices, but I'll stick with the Google's (GOOG) and Apple's (AAPL) of the world. Both are also growing plenty fast and produce exceptional returns on capital.
Highly profitable, real businesses, with fortress balance sheets.
No accounting gimmicks required.
Adam
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, July 27, 2011
Is Bank of America Undervalued? Bruce Berkowitz of Fairholme Thinks So.
Bruce Berkowitz of Fairholme Capital Management has been rather aggressive when it comes to financial stocks lately. In fact, Fairholme's portfolio has just under 75% exposure to financials. This is in stark contrast to Donald Yacktman, another capable equity mutual fund manager, who's funds have less than 5% exposure to financials.
In this speech back in June, Berkowitz first outlines the headwinds facing Bank of America (BAC) then goes on make his case for the bank.
The following are some excerpts from the speech:
"Bank of America generates before reserving for bad loans and before taxes, $45-50 billion a year. That's $4.50 to $5 a share for a company that's selling for $11 and change, before provisioning for bad loans, and before taxes. That's $3.50 to $4 per share before taxes. It's going to be a long time before they pay taxes, given that they have to blow through $80 billion roughly of past losses. Which means the next $80 billion that they make, they don't pay any taxes on. So, that's $3.50 to $4."
So is it cheap?
The bank is actually now selling for just under $ 10/share. To me, the bank's balance sheet and relative ability to absorb losses via earning power is not nearly as robust as stronger banks like Wells Fargo (WFC) or U.S. Bancorp. (USB).
The bank is actually now selling for just under $ 10/share. To me, the bank's balance sheet and relative ability to absorb losses via earning power is not nearly as robust as stronger banks like Wells Fargo (WFC) or U.S. Bancorp. (USB).
"...the period that we're in right now is very reminiscent of the early 90s. I remember having a gigantic position in Wells Fargo. Everyone thought they were going to go bust, because they had all of these empty commercial buildings in California and all over the place. They didn't go bust."
That was around the time that Warren Buffett first bought Wells Fargo.
Those who bought Wells Fargo in the early 1990s and held on saw their investment increase in value, including dividends, roughly 10x over the next decade or so. Buffett has, it's worth noting, added substantially to that position in recent years and often at higher than recent market prices.
More from Berkowitz:
"If I use the money just to buy back stock, and the stock for some reason stays where it is for 10 billion shares, it would take them six years. In six years, they'll buy the entire company back that started in 1794 and had hundreds of billions of dollars of acquisitions that probably touches one out of every two people in the United States. Given the fact that they're not going to pay taxes, they'll probably buy back all the stock in five years."
Those who bought Wells Fargo in the early 1990s and held on saw their investment increase in value, including dividends, roughly 10x over the next decade or so. Buffett has, it's worth noting, added substantially to that position in recent years and often at higher than recent market prices.
More from Berkowitz:
"If I use the money just to buy back stock, and the stock for some reason stays where it is for 10 billion shares, it would take them six years. In six years, they'll buy the entire company back that started in 1794 and had hundreds of billions of dollars of acquisitions that probably touches one out of every two people in the United States. Given the fact that they're not going to pay taxes, they'll probably buy back all the stock in five years."
One big risk (among others) is that a new crisis emerges in the financial sector before Bank of America can get most of its current headwinds behind it. I'm not willing to put a whole lot of capital at risk in a bank less able to withstand the financial stress. Still, if bought near recent prices and if they do get past their current problems, Bank of America will likely make investors a very nice return.
"This is how we do it. And usually it means buying something that's hated. And something where the newspaper everyday is going to tell you, 'You're wrong.' And your friends are going to tell you, 'You're wrong.' There's going to be something else that is hot and juicy, some new thing which you are going to want to get in on, and you usually feel pretty lousy about it. Because, when you're early, you look wrong. You make your most money when times are at their toughest. You just don't know it at the time."
A year ago the valuation gap between Wells Fargo, the significantly sturdier bank, and Bank of America was small. Bank of America might now be relatively cheaper but seems quite likely not built to withstand heavy losses in the way that Wells Fargo can if an unforeseen crisis emerges. I've referenced the following quote before but how cheaply a bank obtains its money is important to consider in this context:
"If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot." - Warren Buffett talking to CNBC on May 2, 2009
Bank of America has higher "raw material costs". That, all else equal, makes it the more vulnerable bank. So while under the right circumstances Fairholme's investment thesis is likely to work out just fine, I'll take Wells Fargo or U.S. Bancorp on a risk/reward basis over the long haul.
Adam
Established long positions in Wells Fargo and U.S. Bancorp at substantially lower than current market prices. Currently building a small long position in Bank of America.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, July 26, 2011
Bove: Ripple Effects of the Debt Stalemate
On Monday, Larry Kudlow of CNBC interviewed Dick Bove. During the interview, Bove warned that the ripple effects would be severe if the debt ceiling stalemate results in higher borrowing costs.
Ripple Effects of Debt Stalemate
I realize that there are many strong views on this debt ceiling and budget battle. That's, of course, as it should be.
The U.S. now has low borrowing costs as a country. This is no small advantage (though not to be taken for granted). It provides, even if not infinite, a runway potentially long enough to solve the structural problems.
Now, those low borrowing costs may not disappear as a result of the high stakes political/economic roulette game being played here but why mess around. A little humble respect for the complexity of these interconnected systems would be nice.
The U.S. needs budget reforms in a big way. Yet, a sudden increase to U.S. borrowing costs and these very real and troublesome problems we have now theoretically become more of a true crisis*.
(Especially if in combination with eurozone sovereign debt problems and their relatively weak banking system.)
A financial system relies on the trust and confidence of humans as basic building blocks. A complex system built this way has the potential for a whole range of not knowable outcomes if that trust and confidence begins to disappear. We are talking here about sometimes-manic-other-times-depressive human market participants that often move in dangerous herds, not the coldly calculated types we'd all like to imagine.
Ripple Effects of Debt Stalemate
I realize that there are many strong views on this debt ceiling and budget battle. That's, of course, as it should be.
The U.S. now has low borrowing costs as a country. This is no small advantage (though not to be taken for granted). It provides, even if not infinite, a runway potentially long enough to solve the structural problems.
Now, those low borrowing costs may not disappear as a result of the high stakes political/economic roulette game being played here but why mess around. A little humble respect for the complexity of these interconnected systems would be nice.
The U.S. needs budget reforms in a big way. Yet, a sudden increase to U.S. borrowing costs and these very real and troublesome problems we have now theoretically become more of a true crisis*.
(Especially if in combination with eurozone sovereign debt problems and their relatively weak banking system.)
A financial system relies on the trust and confidence of humans as basic building blocks. A complex system built this way has the potential for a whole range of not knowable outcomes if that trust and confidence begins to disappear. We are talking here about sometimes-manic-other-times-depressive human market participants that often move in dangerous herds, not the coldly calculated types we'd all like to imagine.
I am not saying it won't work out okay but we are taking some silly risks here. Who knows when trust and confidence becomes scarce. Trust and confidence is a bit like oxygen. You don't think about it much until there's little of it.
So how will this debt/budget battle end up ultimately impacting the financial system or global economy as a whole? From this article:
"The fact is, no one knows when or what deal will be cut. Those who are predicting this outcome are guessing. The ultimate effect on stocks and bonds in the short or long term is also unknown. But we keep tuning in, hoping for an answer, listening to confident and educated individuals making predictions."
I think it is wise to be a little skeptical of those in the business of forecasting who think they do know how it will impact the system and economy. With enough folks making bold guesses someone ends up right with fame and books to follow. There's little accountability for those who made the incorrect predictions. It pays to make extreme predictions.
"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%." - Warren Buffett in the 1994 Berkshire Hathaway (BRKa) Shareholder Letter
It's important to know the limits of what one can foresee.
"A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett in the 1994 Berkshire Hathaway Shareholder Letter
A bit of humility, sound pragmatism, and compromise is much needed to resolve our debt and budget troubles.
Yet, in the context of investing, the macro stuff has less impact on long-term returns than most think. It comes down to buying good businesses at an appropriate discount to a conservative estimate of value.
Otherwise, expect external shocks, some severe, from time to time.
Adam
* If only our debt ceiling/fiscal issues were happening in a vacuum. Consider the potentially unpredictable interaction that could occur if U.S. financial troubles hit the eurozone while it attempts to resolve its own sovereign debt issues while dealing with that regions much weaker banking system. That region has a remarkably fragile financial and monetary system at this time. It's not like their troubles can't unravel in ways that feedback and damage our own financial infrastructure. In other words, making what would be a manageable problem in a vacuum extremely difficult to say the least.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything
"The fact is, no one knows when or what deal will be cut. Those who are predicting this outcome are guessing. The ultimate effect on stocks and bonds in the short or long term is also unknown. But we keep tuning in, hoping for an answer, listening to confident and educated individuals making predictions."
I think it is wise to be a little skeptical of those in the business of forecasting who think they do know how it will impact the system and economy. With enough folks making bold guesses someone ends up right with fame and books to follow. There's little accountability for those who made the incorrect predictions. It pays to make extreme predictions.
"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%." - Warren Buffett in the 1994 Berkshire Hathaway (BRKa) Shareholder Letter
It's important to know the limits of what one can foresee.
"A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett in the 1994 Berkshire Hathaway Shareholder Letter
A bit of humility, sound pragmatism, and compromise is much needed to resolve our debt and budget troubles.
Yet, in the context of investing, the macro stuff has less impact on long-term returns than most think. It comes down to buying good businesses at an appropriate discount to a conservative estimate of value.
Otherwise, expect external shocks, some severe, from time to time.
Adam
* If only our debt ceiling/fiscal issues were happening in a vacuum. Consider the potentially unpredictable interaction that could occur if U.S. financial troubles hit the eurozone while it attempts to resolve its own sovereign debt issues while dealing with that regions much weaker banking system. That region has a remarkably fragile financial and monetary system at this time. It's not like their troubles can't unravel in ways that feedback and damage our own financial infrastructure. In other words, making what would be a manageable problem in a vacuum extremely difficult to say the least.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything
Buffett on Absolute & Relative Performance: Berkshire Shareholder Letter Highlights
Warren Buffett wrote the following in the 2001 Berkshire Hathaway (BRKa) shareholder letter:
On Absolute and Relative Performance
Two years ago, reporting on 1999, I said that we had experienced both the worst absolute and relative performance in our history. I added that "relative results are what concern us," a viewpoint I've had since forming my first investment partnership on May 5, 1956. Meeting with my seven founding limited partners that evening, I gave them a short paper titled "The Ground Rules" that included this sentence: "Whether we do a good job or a poor job is to be measured against the general experience in securities." We initially used the Dow Jones Industrials as our benchmark, but shifted to the S&P 500 when that index became widely used. Our comparative record since 1965 is chronicled on the facing page; last year Berkshire’s advantage was 5.7 percentage points.
Some people disagree with our focus on relative figures, arguing that "you can’t eat relative performance." But if you expect - as Charlie Munger, Berkshire's Vice Chairman, and I do - that owning the S&P 500 will produce reasonably satisfactory results over time, it follows that, for long-term investors, gaining small advantages annually over that index must prove rewarding.
Buffett later added...
Though our corporate performance last year was satisfactory, my performance was anything but. I manage most of Berkshire's equity portfolio, and my results were poor, just as they have been for several years.
Most compensation packages are still designed in a way that produces vastly different results for senior executives compared to the owners.
I'm realistic in that one cannot expect every senior executive to keep 99% of his wealth with no intent to sell in the business he/she runs. Yet, in too many public companies, senior managers have little skin in the game with compensation packages often structured such that effectively heads and tails is a win for them regardless of long run business performance and shareholder value creation.
Adam
Long position BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
On Absolute and Relative Performance
Two years ago, reporting on 1999, I said that we had experienced both the worst absolute and relative performance in our history. I added that "relative results are what concern us," a viewpoint I've had since forming my first investment partnership on May 5, 1956. Meeting with my seven founding limited partners that evening, I gave them a short paper titled "The Ground Rules" that included this sentence: "Whether we do a good job or a poor job is to be measured against the general experience in securities." We initially used the Dow Jones Industrials as our benchmark, but shifted to the S&P 500 when that index became widely used. Our comparative record since 1965 is chronicled on the facing page; last year Berkshire’s advantage was 5.7 percentage points.
Some people disagree with our focus on relative figures, arguing that "you can’t eat relative performance." But if you expect - as Charlie Munger, Berkshire's Vice Chairman, and I do - that owning the S&P 500 will produce reasonably satisfactory results over time, it follows that, for long-term investors, gaining small advantages annually over that index must prove rewarding.
Buffett later added...
Though our corporate performance last year was satisfactory, my performance was anything but. I manage most of Berkshire's equity portfolio, and my results were poor, just as they have been for several years.
On Alignment of Interests
Another of my 1956 Ground Rules remains applicable: "I cannot promise results to partners." But Charlie and I can promise that your economic result from Berkshire will parallel ours during the period of your ownership: We will not take cash compensation, restricted stock or option grants that would make our results superior to yours.
Additionally, I will keep well over 99% of my net worth in Berkshire. My wife and I have never sold a share nor do we intend to. Charlie and I are disgusted by the situation, so common in the last few years, in which shareholders have suffered billions in losses while the CEOs, promoters, and other higher-ups who fathered these disasters have walked away with extraordinary wealth. Indeed, many of these people were urging investors to buy shares while concurrently dumping their own, sometimes using methods that hid their actions. To their shame, these business leaders view shareholders as patsies, not partners.
Most compensation packages are still designed in a way that produces vastly different results for senior executives compared to the owners.
Adam
Long position BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, July 25, 2011
Social Media: An Overheated Microclimate in a Temperate Investing Zone
Th enthusiasm for social-media stocks is getting awful high and Michael Santoli wrote about it in this recent Barron's article:
Barron's: Bubble Trouble
According to the article, the combined revenue of eight leading social-media businesses (that are apparently being value at $ 200 billion) is only $ 3.5 billion (yikes!).
The article also points out that the Washington Post (WPO) alone, with a market value of $ 3.4 billion (a mere $ 196 billion plus less), has more in revenue (actually, roughly $ 1 billion more).
In addition, Some of the large public technology companies (Google: GOOG, Apple; AAPL, Microsoft: MSFT among others) carry modest valuations relative to earnings yet stand to potentially benefit from trends in mobile computing and/or social media in significant ways.
From the Barron's article.
...this isn't a straight replay of the '90s tech bubble, and therefore not a once-in-a-century misallocation of capital that will collapse a broad swath of the U.S. stock market...But in a market where...20% of large tech stocks trade at single-digit price/earnings ratios, the social-media group looks to be an overheated microclimate in a generally temperate investing zone.
Large cap tech stocks also happen to be much better capitalized and have relatively proven businesses to fund future investments in the bigger opportunities.
So even if upside is more limited (as is the downside), an investor can participate in some rather dynamic trends but doesn't have to speculate nearly as much to produce a nice return.
Check out the full article.
Adam
Long positions in WPO, GOOG, AAPL, and MSFT
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Barron's: Bubble Trouble
According to the article, the combined revenue of eight leading social-media businesses (that are apparently being value at $ 200 billion) is only $ 3.5 billion (yikes!).
The article also points out that the Washington Post (WPO) alone, with a market value of $ 3.4 billion (a mere $ 196 billion plus less), has more in revenue (actually, roughly $ 1 billion more).
In addition, Some of the large public technology companies (Google: GOOG, Apple; AAPL, Microsoft: MSFT among others) carry modest valuations relative to earnings yet stand to potentially benefit from trends in mobile computing and/or social media in significant ways.
From the Barron's article.
...this isn't a straight replay of the '90s tech bubble, and therefore not a once-in-a-century misallocation of capital that will collapse a broad swath of the U.S. stock market...But in a market where...20% of large tech stocks trade at single-digit price/earnings ratios, the social-media group looks to be an overheated microclimate in a generally temperate investing zone.
Large cap tech stocks also happen to be much better capitalized and have relatively proven businesses to fund future investments in the bigger opportunities.
So even if upside is more limited (as is the downside), an investor can participate in some rather dynamic trends but doesn't have to speculate nearly as much to produce a nice return.
Check out the full article.
Adam
Long positions in WPO, GOOG, AAPL, and MSFT
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Buffett on Gambling and Speculation
In this earlier post, Warren Buffett explained how he differentiates investing from speculating. Buffett made a further destinction between gambling and speculating in front of the Financial Crisis Inquiry Commission. Here's the way he explained it:
"I wrote a letter in 1982 to Congressman Dingell, giving my views when they were introducing the S&P index future.
And I said there are legitimate uses for hedging out the long positions and so on. But I said, overwhelmingly, it's going to become a gambling vehicle.
And I would distinguish between speculative and gambling. Gambling involves, in my view, the creation of a risk where no risk need be created.
Now, obviously, if you plant a crop in the spring and you're going to harvest in the fall, you are speculating on what prices are going to be in the fall for your corn or oats or whatever it may be. And you may lay that off on some other speculator.
But that's a risk that the system has to take. You can't grow it in one day. But when you start wagering on — well, on stock index futures, I think that gambling instincts are very strong in humans." - Warren Buffett speaking to the Financial Crisis Inquiry Commission
It's worth noting that, with all participants considered, investing need not be a zero-sum game. In contrast, the very nature of gambling can be no better than zero-sum while speculation, in aggregate, adds nothing but incremental and often unnecessary frictional costs.** Investing, gambling, and speculation may seem similar but only if they are defined rather imprecisely. Well, it seems the latter two things are now swamping the former in the current market environment. This may not be as destructive as ideas like the efficient market hypothesis or the theory of rational expectations*, but I'm of a view that the system is weaker than it would otherwise be because of the sheer quantity of speculation and gambling now going on. As a result, the system in its current form is less capable of performing its essential functions.
"When the price of a stock can be influenced by a 'herd' on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical." - Warren Buffett in the Superinvestors of Graham-and-Doddsville
"When the price of a stock can be influenced by a 'herd' on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical." - Warren Buffett in the Superinvestors of Graham-and-Doddsville
Financial markets have been and will likely always be rather manic and depressive in nature. It's hardly a new problem. Mood swings in markets will, almost certainly, continue to produce substantially mispriced marketable securities from time to time.
"The market is a psychotic, drunk, manic-depressive selling 4,000 companies every day. In one year, the high will double the low. These businesses are no more volatile than a farm or an apartment block [whose values do not swing so wildly]." - Warren Buffett at Wharton***
The fact is market participants, at times, move in herds in a way that takes price action to extremes. In any case, they're certainly not always the coldly calculated types some seem to imagine.
"The market is a psychotic, drunk, manic-depressive selling 4,000 companies every day. In one year, the high will double the low. These businesses are no more volatile than a farm or an apartment block [whose values do not swing so wildly]." - Warren Buffett at Wharton***
The fact is market participants, at times, move in herds in a way that takes price action to extremes. In any case, they're certainly not always the coldly calculated types some seem to imagine.
"I have not been a great fan of the theory of rational expectations – the belief in cold, rational, calculating homo sapiens; indeed, I believe it to be the greatest-ever failure of economic theory, which goes a long way toward explaining how completely useless economists were at warning us of the approaching crisis (with a half handful of honorable exceptions)." - Jeremy Grantham in his Finance Goes Rogue Essay
I just think modern financial markets have developed in a way that, if anything, unnecessarily amplifies this nature.
The holding period for stocks is at an all-time low (for the first time measured in just a few months after being measured in multiple years for most of the past century).
So there are more short-term oriented participants than ever, fewer owners.
We benefit from a system that as often as possible produces market prices approximating the discounted value of what assets can produce over its given life. To me, that begins with having more market participants grounded first and foremost by the intrinsic value of underlying assets and fewer making short-term bets. There's certainly nothing inherently wrong with speculation (in fact, having a certain amount of short-term oriented participation is vital) but, as in pretty much any healthy system, proportion matters.
There will always be certain assets where it's challenging to estimate value. For example, new business startups in highly dynamic industries. Those sorts of assets will naturally have a whole range of possible values. Well, there will inevitably be speculative bets on who the winners and losers are likely going to be and it's hard to see why or how it would be desirable to reign that sort of thing in.
There will always be certain assets where it's challenging to estimate value. For example, new business startups in highly dynamic industries. Those sorts of assets will naturally have a whole range of possible values. Well, there will inevitably be speculative bets on who the winners and losers are likely going to be and it's hard to see why or how it would be desirable to reign that sort of thing in.
Yet, the mispricing of assets for extended periods of time leads to the misallocation of capital and other resources. Ultimately, that likely throttles potential wealth creation. It sure seem that modifying incentives and some other wise changes to encourage more long-term investing and less speculation (and especially pure gambling) makes sense. Maybe there'd be fewer and less extreme mispricing in the capital markets. That would be a good thing from an overall system perspective (even if it makes life more difficult for individual investors who attempt to profit from mispriced marketable securities).
Basically, less short-termism seems in order. Something both Warren Buffett and John Bogle have called for formally in recent years. In this statement, signed by both of them along with 26 others, they recommended changes to the system that would encourage market participants to take more of a long view.
Gambling, even when frictional costs are ignored, is no better than a zero-sum game.
Speculation is, at least in aggregate, much the same.
Investment need not be.
Gambling, even when frictional costs are ignored, is no better than a zero-sum game.
Speculation is, at least in aggregate, much the same.
Investment need not be.
Adam
Related posts:
Buffett on Speculation and Investment - Part II
Buffett on Speculation and Investment
Related posts:
Buffett on Speculation and Investment - Part II
Buffett on Speculation and Investment
* Charlie Munger, in November of 2000, talked about efficient markets and the theory of rational expectations: "The possibility that stock value in aggregate can become irrationally high is contrary to the hard-form 'efficient market' theory that many of you once learned as gospel from your mistaken professors of yore. Your mistaken professors were too much influenced by 'rational man' models of human behavior from economics and too little by 'foolish man' models from psychology and real-world experience."
** Ultimately, the returns for market participants as a whole is dictated by what the underlying assets produce over the long haul minus all the frictional costs. So speculation in total adds nothing and, once all costs are considered, actually subtracts from returns. Gambling is also less than zero-sum whenever frictional costs exist.
*** Based upon notes that were taken at a 2006 Wharton meeting.
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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.
** Ultimately, the returns for market participants as a whole is dictated by what the underlying assets produce over the long haul minus all the frictional costs. So speculation in total adds nothing and, once all costs are considered, actually subtracts from returns. Gambling is also less than zero-sum whenever frictional costs exist.
*** Based upon notes that were taken at a 2006 Wharton meeting.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, July 22, 2011
Buffett on Speculation and Investment - Part II
A follow up to this post:
Buffett on Speculation and Investment
"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices." - Benjamin Graham in The Intelligent Investor
Speculators generally focus on price action in the near term.
For investors, it's mostly not about price action, it's about what the asset can produce in the long run relative to what was paid for the asset.
What the price does next week, month, or even much longer matters little.
Speculators take on risk and enable other participants manage/transfer risk. It can be a very useful and beneficial role. Yet, in the markets, the proportion of activity that is pure speculating versus investing matters.
It's not difficult to show that, in many systems, more of what is initially a useful thing creates diminishing returns or worse.
The following may help to illustrate the point.
It's certainly no perfect analogy but consider a petrol engine. It happens to operate best when the stoichiometric air-fuel ratio is very near 14.7 to 1 (mass ratio of air to fuel present during combustion). Get much above or below that ratio and the engine performs poorly (or not at all). In other words, it's not like more fuel is always better. Eventually too much fuel destroys performance.
So there is a narrow operating range around that ratio for the engine to perform its best. For a petrol engine, the air-fuel ratio for optimum performance happens to hover around 14.7 to 1.
Of course, I'm not suggesting that specific ratio -- or any precise ratio -- applies to capital markets. With too much air a petrol engine simply won't run. That's not necessarily the case for capital markets. Clearly, any system involving lots of temperamental human participants could never have such precision. So just because it's not working optimally doesn't mean it won't work at all. Still, I think it's fair to say the market has developed in ways that are way beyond being even in the ballpark of an optimal ratio of speculators (i.e. the air) in proportion to the investment-oriented participants (i.e. the fuel).
The equivalent to an "air-fuel" ratio for the markets has, in my view, become more than just a bit out of balance in recent years. The relatively small amount of actual investing compared to substantial speculation, and in some cases pure gambling, is making the market engine run a bit lean.*
The assumption that more is better, even when it's something initially beneficial, is where I think a mistake is being made. There's this prevailing belief that if some initially beneficial added market liquidity is good then anything short of an infinite amount more of it must be better. I think it is wise to be a bit skeptical of this.
"A modest amount of liquidity will service the true needs of a civilization. A large amount of liquidity will bring out the worst in human nature." - Charlie Munger at the 2008 Wesco Financial Shareholder Meeting
Buffett makes a further distinction between speculation and gambling that I'll address in a follow-up.
Adam
Related posts:
Buffett on Gambling and Speculation (follow-up)
Buffett on Speculation and Investment
* Running either rich (too much fuel) or lean (too little fuel) means lost performance in an engine.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Buffett on Speculation and Investment
"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices." - Benjamin Graham in The Intelligent Investor
Speculators generally focus on price action in the near term.
For investors, it's mostly not about price action, it's about what the asset can produce in the long run relative to what was paid for the asset.
What the price does next week, month, or even much longer matters little.
Speculators take on risk and enable other participants manage/transfer risk. It can be a very useful and beneficial role. Yet, in the markets, the proportion of activity that is pure speculating versus investing matters.
It's not difficult to show that, in many systems, more of what is initially a useful thing creates diminishing returns or worse.
The following may help to illustrate the point.
It's certainly no perfect analogy but consider a petrol engine. It happens to operate best when the stoichiometric air-fuel ratio is very near 14.7 to 1 (mass ratio of air to fuel present during combustion). Get much above or below that ratio and the engine performs poorly (or not at all). In other words, it's not like more fuel is always better. Eventually too much fuel destroys performance.
So there is a narrow operating range around that ratio for the engine to perform its best. For a petrol engine, the air-fuel ratio for optimum performance happens to hover around 14.7 to 1.
Of course, I'm not suggesting that specific ratio -- or any precise ratio -- applies to capital markets. With too much air a petrol engine simply won't run. That's not necessarily the case for capital markets. Clearly, any system involving lots of temperamental human participants could never have such precision. So just because it's not working optimally doesn't mean it won't work at all. Still, I think it's fair to say the market has developed in ways that are way beyond being even in the ballpark of an optimal ratio of speculators (i.e. the air) in proportion to the investment-oriented participants (i.e. the fuel).
The equivalent to an "air-fuel" ratio for the markets has, in my view, become more than just a bit out of balance in recent years. The relatively small amount of actual investing compared to substantial speculation, and in some cases pure gambling, is making the market engine run a bit lean.*
The assumption that more is better, even when it's something initially beneficial, is where I think a mistake is being made. There's this prevailing belief that if some initially beneficial added market liquidity is good then anything short of an infinite amount more of it must be better. I think it is wise to be a bit skeptical of this.
"A modest amount of liquidity will service the true needs of a civilization. A large amount of liquidity will bring out the worst in human nature." - Charlie Munger at the 2008 Wesco Financial Shareholder Meeting
Buffett makes a further distinction between speculation and gambling that I'll address in a follow-up.
Adam
Related posts:
Buffett on Gambling and Speculation (follow-up)
Buffett on Speculation and Investment
* Running either rich (too much fuel) or lean (too little fuel) means lost performance in an engine.
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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, July 21, 2011
Final Wesco Meeting: More from Charlie Munger
One final post on things of note that Charlie Munger had to say at what was effectively the final Wesco Financial annual meeting.
On Financiers
"To the extent that all I've done is pick stocks that have gone up, and sat on my ass as my family got richer, I haven't left much contribution to society. I guess it's a lot like Wall Street. The difference is, I feel ashamed of it. I try to make up for it with philanthropy and meetings like this one today. This meeting is not out of kindness. This is atonement."
On Banks
"Wells Fargo (NYSE: WFC) and US Bancorp (NYSE: USB) avoid stupidity better than most. And Wells admits that it had its head up its ass when it made some of its mortgage loans. They know it wasn't their finest moment. I'm comfortable with people like that."
On Humility
"I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn."
Always entertaining, insightful, and blunt.
Charlie Munger has had a loyal following of shareholders come to this meeting for years so he decided to hold one last conference and pay for it himself.
Check out the full article.
Adam
Long BRKb, WFC, and USB
Related posts:
Charlie Munger on Accountants & High Speed Traders
Final Wesco Meeting: A Morning With Charlie Munger
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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.
Wesco is no longer publicly traded after Berkshire Hathaway (BRK-A) acquired the remaining shares of the company last month.
On Financiers
"To the extent that all I've done is pick stocks that have gone up, and sat on my ass as my family got richer, I haven't left much contribution to society. I guess it's a lot like Wall Street. The difference is, I feel ashamed of it. I try to make up for it with philanthropy and meetings like this one today. This meeting is not out of kindness. This is atonement."
On Banks
"Wells Fargo (NYSE: WFC) and US Bancorp (NYSE: USB) avoid stupidity better than most. And Wells admits that it had its head up its ass when it made some of its mortgage loans. They know it wasn't their finest moment. I'm comfortable with people like that."
On Humility
"I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn."
Always entertaining, insightful, and blunt.
Charlie Munger has had a loyal following of shareholders come to this meeting for years so he decided to hold one last conference and pay for it himself.
Check out the full article.
Adam
Long BRKb, WFC, and USB
Related posts:
Charlie Munger on Accountants & High Speed Traders
Final Wesco Meeting: A Morning With Charlie Munger
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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.
Wednesday, July 20, 2011
Apple's 3Q Earnings Report
Apple's earnings released yesterday was certainly impressive by any measure. Consider that, back in 2008, Apple (AAPL) earned $ 4.8 billion during that full year.
An impressive amount by any standard but especially when you consider that five years earlier, in 2003, the company was barely breaking even.
Apple Reports 3rd Quarter 2011 Results: July 19, 2011
Apple Reports 3rd Quarter 2011 Results: July 19, 2011
In Apple's most recent quarterly earnings release, the company revealed earnings of $ 7.3 billion. So Apple is able to now produce far more earnings in 13 weeks than what it could produce in a full year back in 2008.
Here's a non-tech comparison. Apple's quarterly earnings was also more than the expected annualized 2011 earnings of Pepsi (PEP).
Here's a non-tech comparison. Apple's quarterly earnings was also more than the expected annualized 2011 earnings of Pepsi (PEP).
Google's (GOOG) most recent quarterly results was also very impressive but what Apple is doing is hard to believe. It will be interesting to see how this compares to Microsoft (MSFT) when that company reports tomorrow.
Apple now has $ 76 billion of cash and marketable securities on the balance sheet with no debt. One heck of a pile of cash. That's $ 81 in net cash per share. Not that they need the headaches or risks but Apple could capitalize a pretty good size bank with that much capital.
From the latest Apple earnings release:
The Company posted record quarterly revenue of $28.57 billion and record quarterly net profit of $7.31 billion, or $7.79 per diluted share. These results compare to revenue of $15.70 billion and net quarterly profit of $3.25 billion, or $3.51 per diluted share, in the year-ago quarter. Gross margin was 41.7 percent compared to 39.1 percent in the year-ago quarter. International sales accounted for 62 percent of the quarter’s revenue.
The Company sold 20.34 million iPhones in the quarter, representing 142 percent unit growth over the year-ago quarter. Apple sold 9.25 million iPads during the quarter, a 183 percent unit increase over the year-ago quarter. The Company sold 3.95 million Macs during the quarter, a 14 percent unit increase over the year-ago quarter. Apple sold 7.54 million iPods, a 20 percent unit decline from the year-ago quarter.
They sold nearly 9.25 million units of a product, the iPad, that wasn't even part of the portfolio until recently.
Pretty much every iPad they could make was sold.
"We're thrilled to deliver our best quarter ever, with revenue up 82 percent and profits up 125 percent," said Steve Jobs, Apple's CEO.
The company's 82% revenue growth and 125% earnings growth is not exactly coming off of a small base. Last year's numbers looked remarkable at the time yet Apple continues an unprecedented growth rate for a company its size.
This Forbes article points out China grew 6x year-over-year to $ 3.8 billion for the latest quarter.
Now, consider the valuation. The company is well on it's way to earning $ 25 to 27 billion this year and most likely much more next year. The stock is up substantially in recent weeks to new highs and approaching $ 388/share giving it a market value of $ 364 billion. Subtract the $ 76 billion in cash on the balance sheet and you have an enterprise value of $ 288 billion.
Is a $ 288 billion valuation too much for a business making $ 25 to $ 27 billion this year that's still growing rapidly?
It's the only company I can remember whose exceptional stock performance is upstaged by even more exceptional business performance. I said the following recently about Google but it applies even more so to Apple:
There are many inferior businesses selling for much higher multiples of earnings these days.
Adam
Established small long positions in AAPL, GOOG, PEP at much lower than current market prices and MSFT slightly below recent 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 and educational use and the opinions found here should not be treated as specific individualized investment advice. 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.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational and educational use and the opinions found here should not be treated as specific individualized investment advice. 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.
Tuesday, July 19, 2011
Buffett on Enduring Competitive Advantage: Berkshire Shareholder Letter Highlights
From Warren Buffett's 2000 Berkshire Hathaway (BRKa) shareholder letter:
"Despite State Farm's strengths, however, GEICO has much the better business model, one that embodies significantly lower operating costs. And, when a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. This enduring competitive advantage of GEICO - one it possessed in 1951 when, as a 20-year-old student, I first became enamored with its stock - is the reason that over time it will inevitably increase its market share significantly while simultaneously achieving excellent profits."
You see this fits a pattern when you consider what Buffett said a couple years ago about two very different types of businesses. He spoke of Wells Fargo (WFC) and more generally about copper producers in this CNBC interview to highlight the importance of a sustainable low-cost position. The "raw material" for a bank, of course, is money and the cost of it relative to competitors is all-important. The same is true for a copper producer:
"If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot." - Warren Buffett talking to CNBC on May 2, 2009
An enduring low cost position is one source of competitive advantage that you'll see at the core of Berkshire Hathaway's portfolio of businesses (whether partially owned via shares in common stocks or owned outright).
Another common stock held within the Berkshire portfolio that has a low cost position is Wal-Mart (WMT).
"...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill." - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Having an enduring low cost advantage is one important source of economic Goodwill. In the 1983 letter, Buffett goes on to explain what he thinks the major sources of economic Goodwill happen to be:
"...a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry." - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Coca-Cola (KO), Kraft (KFT), Johnson & Johnson (JNJ), and See's Candies are all good examples of enduring consumer franchises.
An idea related to all of this is the economic moat of a business. It's a term referring to the characteristics that determine the longevity of competitive advantage for a single business within an industry. The economic moat protects a firms excess return potential.
Some moats are sustainable for decades while others are not.
Whether a business can sustain or enhance its moat to protect those excess returns is the key question.
You'll find many other examples of consumer franchises and low cost producers in the Berkshire Hathaway portfolio.
The businesses Berkshire owns partially (in the case of common stocks) or entirely tend to derive their competitive advantages from one of these two sources.
Check out the portfolio and it becomes pretty clear most of the businesses have at least one of these two forms of competitive advantage.
Adam
Long the stocks mentioned in this post
* Accounting Goodwill is very different from economic Goodwill. The appendix in the 1983 Berkshire Hathaway shareholder letter provides a complete explanation of the difference between economic Goodwill and accounting Goodwill. From the letter: "This appendix deals only with economic and accounting Goodwill – not the goodwill of everyday usage. For example, a business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, before the breakup, was generally well thought of, but possessed not a dime of economic Goodwill.) And, regrettably, a business may be disliked by its customers but possess substantial, and growing, economic Goodwill. So, just for the moment, forget emotions and focus only on economics and accounting."
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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.
"Despite State Farm's strengths, however, GEICO has much the better business model, one that embodies significantly lower operating costs. And, when a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. This enduring competitive advantage of GEICO - one it possessed in 1951 when, as a 20-year-old student, I first became enamored with its stock - is the reason that over time it will inevitably increase its market share significantly while simultaneously achieving excellent profits."
You see this fits a pattern when you consider what Buffett said a couple years ago about two very different types of businesses. He spoke of Wells Fargo (WFC) and more generally about copper producers in this CNBC interview to highlight the importance of a sustainable low-cost position. The "raw material" for a bank, of course, is money and the cost of it relative to competitors is all-important. The same is true for a copper producer:
"If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot." - Warren Buffett talking to CNBC on May 2, 2009
An enduring low cost position is one source of competitive advantage that you'll see at the core of Berkshire Hathaway's portfolio of businesses (whether partially owned via shares in common stocks or owned outright).
Another common stock held within the Berkshire portfolio that has a low cost position is Wal-Mart (WMT).
"...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill." - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Having an enduring low cost advantage is one important source of economic Goodwill. In the 1983 letter, Buffett goes on to explain what he thinks the major sources of economic Goodwill happen to be:
"...a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry." - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Coca-Cola (KO), Kraft (KFT), Johnson & Johnson (JNJ), and See's Candies are all good examples of enduring consumer franchises.
An idea related to all of this is the economic moat of a business. It's a term referring to the characteristics that determine the longevity of competitive advantage for a single business within an industry. The economic moat protects a firms excess return potential.
Some moats are sustainable for decades while others are not.
Whether a business can sustain or enhance its moat to protect those excess returns is the key question.
You'll find many other examples of consumer franchises and low cost producers in the Berkshire Hathaway portfolio.
The businesses Berkshire owns partially (in the case of common stocks) or entirely tend to derive their competitive advantages from one of these two sources.
Check out the portfolio and it becomes pretty clear most of the businesses have at least one of these two forms of competitive advantage.
Adam
Long the stocks mentioned in this post
* Accounting Goodwill is very different from economic Goodwill. The appendix in the 1983 Berkshire Hathaway shareholder letter provides a complete explanation of the difference between economic Goodwill and accounting Goodwill. From the letter: "This appendix deals only with economic and accounting Goodwill – not the goodwill of everyday usage. For example, a business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, before the breakup, was generally well thought of, but possessed not a dime of economic Goodwill.) And, regrettably, a business may be disliked by its customers but possess substantial, and growing, economic Goodwill. So, just for the moment, forget emotions and focus only on economics and accounting."
---
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, July 18, 2011
Memo to Microsoft: Show Us the Money
Check out this Barron's article:
Memo to Microsoft: Show Us the Money
It turns out a memo to Microsoft (MSFT) from an anonymous hedge fund had to say last week proposed using cash and debt to buy back 20% of the stock and a boost of the dividend to 6%.
Apparently, the memo was authored by Ivory Investment Management, a shareholder since 2006. According to the article, the firm believes in Microsoft's prospects and had nothing negative to say about CEO Steve Ballmer (unlike some other high profile Microsoft shareholders). The focus of Ivory's criticism is on capital structure.
Some other things worth noting.
Microsoft has returned $ 150 billion to shareholders in the past decade in the form of buybacks and dividends. Shares outstanding have dropped by nearly 25% over that time. So, to an extent Microsoft has been doing what the memo asks just not aggressively enough.
(though it's not like $ 150 billion is a trivial sum of money)
In the late 1990s, Microsoft's enterprise value/earnings multiple was ~60x but is now less than 10x. So quite a bit of the stock's poor performance comes down to substantial multiple compression. The business performance, if not nearly as spectacular as something like Google (GOOG) or Apple (AAPL), has actually done just fine.
If Microsoft's business continues to perform then that compressed multiple, if annoying in the short run, will serve patient shareholders in the long run by allowing more shares to be bought cheaply.
The Barron's article also makes the point that since Microsoft can borrow at 3% and use the funds to buy its own stock with a 12% free cash flow yield, it seems an easy call.
I think it is.
What the memo says does make a lot of sense but I wouldn't bet on it happening any time soon at Microsoft.
Yet, there are quite a few other businesses have a similar opportunity to borrow at low rates then buyback a stock that has a much higher earnings yield. The difference in that spread to the direct benefit of remaining shareholders.
There may be an aggravating lag in stock performance but, as long as the business itself performs reasonably well, the benefits measured in enhanced long-term shareholder returns will not be insignificant.
Check out the full article.
Adam
Long positions in MSFT, GOOG, and AAPL
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Memo to Microsoft: Show Us the Money
It turns out a memo to Microsoft (MSFT) from an anonymous hedge fund had to say last week proposed using cash and debt to buy back 20% of the stock and a boost of the dividend to 6%.
Apparently, the memo was authored by Ivory Investment Management, a shareholder since 2006. According to the article, the firm believes in Microsoft's prospects and had nothing negative to say about CEO Steve Ballmer (unlike some other high profile Microsoft shareholders). The focus of Ivory's criticism is on capital structure.
Some other things worth noting.
Microsoft has returned $ 150 billion to shareholders in the past decade in the form of buybacks and dividends. Shares outstanding have dropped by nearly 25% over that time. So, to an extent Microsoft has been doing what the memo asks just not aggressively enough.
(though it's not like $ 150 billion is a trivial sum of money)
In the late 1990s, Microsoft's enterprise value/earnings multiple was ~60x but is now less than 10x. So quite a bit of the stock's poor performance comes down to substantial multiple compression. The business performance, if not nearly as spectacular as something like Google (GOOG) or Apple (AAPL), has actually done just fine.
If Microsoft's business continues to perform then that compressed multiple, if annoying in the short run, will serve patient shareholders in the long run by allowing more shares to be bought cheaply.
The Barron's article also makes the point that since Microsoft can borrow at 3% and use the funds to buy its own stock with a 12% free cash flow yield, it seems an easy call.
I think it is.
What the memo says does make a lot of sense but I wouldn't bet on it happening any time soon at Microsoft.
Yet, there are quite a few other businesses have a similar opportunity to borrow at low rates then buyback a stock that has a much higher earnings yield. The difference in that spread to the direct benefit of remaining shareholders.
There may be an aggravating lag in stock performance but, as long as the business itself performs reasonably well, the benefits measured in enhanced long-term shareholder returns will not be insignificant.
Check out the full article.
Adam
Long positions in MSFT, GOOG, and AAPL
Related post:
Technology Stocks
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, July 15, 2011
Google's 2nd Quarter 2011 Earnings
Before today's big move in the stock, Google (GOOG) had an enterprise value to earnings multiple of approximately 14x.
Even if not cheap, certainly not expensive either.
Well, the company had one heck of a 2nd quarter and today's stock market reaction reflects it. Shares in Google are up more than $ 60/share this morning, roughly 12%, from yesterdays close of $ 528.94. The stock is now selling for more than $ 590/share.
This Bloomberg article summarizes some of the results. Net income in the 2nd quarter increased 36 percent up to $ 2.51 billion compared to the same period last year.
Google's Shares Advance
Revenue also increased over 30% in 2nd quarter 2011 compared to 2nd quarter 2010.
Minyanville added these additional thoughts.
Google's Blowout Earnings
Considering Google's excellent core economics and prospects the stock had become remarkably cheap. It's a rapidly growing company that produces impressive return on capital while maintaining a substantial moat around, at least, the core search business. Businesses with those characteristics seem to, more often than not, end up overvalued.
"Google has a huge new moat, in fact I've probably never seen such a wide moat." - Charlie Munger at a 2009 Press Conference
Google's moat is definitely wide but that doesn't mean it has the durability of something like Coca-Cola (KO). The company clearly has a great position but knowing what the search business will look like in ten years is not an easy call. Coca-Cola's place in the world of beverages ten years from now is far more certain.
Google is financially strong and seems to be gaining traction on multiple fronts. It has roughly $ 34 billion in net cash on the balance sheet. Few companies can generate over $ 10 billion per year in free cash flow yet are still growing at a 30% clip (though Apple has more than 2x the free cash flow and is growing even faster).
Yet, as an investor, you just can't own a Google the way you can own one of "The Inevitables":
Buffett on "The Inevitables"
Companies such as Coca-Cola and Gillette might well be labeled "The Inevitables." Forecasters may differ a bit in their predictions of exactly how much soft drink or shaving-equipment business these companies will be doing in ten or twenty years. Nor is our talk of inevitability meant to play down the vital work that these companies must continue to carry out, in such areas as manufacturing, distribution, packaging and product innovation. In the end, however, no sensible observer - not even these companies' most vigorous competitors, assuming they are assessing the matter honestly - questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime. - Warren Buffett in the 1996 Berkshire Hathaway Shareholder Letter
I'd say, best case, Google is more likely one of the "highly probables".
Considering what it takes to be an inevitable, Charlie and I recognize that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the inevitables in our portfolio, therefore, we add a few "highly probables." - Warren Buffett in the 1996 Berkshire Hathaway Shareholder Letter
After today's move in the stock Google may not be quite as cheap, but there are many inferior businesses selling for much higher multiples of earnings these days.
Adam
Long position in GOOG established at much lower than recent market prices
Even if not cheap, certainly not expensive either.
Well, the company had one heck of a 2nd quarter and today's stock market reaction reflects it. Shares in Google are up more than $ 60/share this morning, roughly 12%, from yesterdays close of $ 528.94. The stock is now selling for more than $ 590/share.
This Bloomberg article summarizes some of the results. Net income in the 2nd quarter increased 36 percent up to $ 2.51 billion compared to the same period last year.
Google's Shares Advance
Revenue also increased over 30% in 2nd quarter 2011 compared to 2nd quarter 2010.
Minyanville added these additional thoughts.
Google's Blowout Earnings
Considering Google's excellent core economics and prospects the stock had become remarkably cheap. It's a rapidly growing company that produces impressive return on capital while maintaining a substantial moat around, at least, the core search business. Businesses with those characteristics seem to, more often than not, end up overvalued.
"Google has a huge new moat, in fact I've probably never seen such a wide moat." - Charlie Munger at a 2009 Press Conference
Google's moat is definitely wide but that doesn't mean it has the durability of something like Coca-Cola (KO). The company clearly has a great position but knowing what the search business will look like in ten years is not an easy call. Coca-Cola's place in the world of beverages ten years from now is far more certain.
Google is financially strong and seems to be gaining traction on multiple fronts. It has roughly $ 34 billion in net cash on the balance sheet. Few companies can generate over $ 10 billion per year in free cash flow yet are still growing at a 30% clip (though Apple has more than 2x the free cash flow and is growing even faster).
Yet, as an investor, you just can't own a Google the way you can own one of "The Inevitables":
Buffett on "The Inevitables"
Companies such as Coca-Cola and Gillette might well be labeled "The Inevitables." Forecasters may differ a bit in their predictions of exactly how much soft drink or shaving-equipment business these companies will be doing in ten or twenty years. Nor is our talk of inevitability meant to play down the vital work that these companies must continue to carry out, in such areas as manufacturing, distribution, packaging and product innovation. In the end, however, no sensible observer - not even these companies' most vigorous competitors, assuming they are assessing the matter honestly - questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime. - Warren Buffett in the 1996 Berkshire Hathaway Shareholder Letter
I'd say, best case, Google is more likely one of the "highly probables".
Considering what it takes to be an inevitable, Charlie and I recognize that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the inevitables in our portfolio, therefore, we add a few "highly probables." - Warren Buffett in the 1996 Berkshire Hathaway Shareholder Letter
After today's move in the stock Google may not be quite as cheap, but there are many inferior businesses selling for much higher multiples of earnings these days.
Adam
Long position in GOOG established at much lower than recent market prices
Thursday, July 14, 2011
Is Facebook Worth $ 100 billion?
A Wall Street Journal article points out that transactions on private marketplaces value Facebook at ~ $ 84 billion and that some think $ 100 billion will be the valuation when it goes public.
How does that possible Facebook valuation compare to other large cap technology-oriented companies?
Company | Enterprise Value* | 2011 Est. Earnings
Apple (AAPL) | $ 268 billion | $ 23 billion
Microsoft (MSFT) | $ 188 billion | $ 22 billion
Oracle (ORCL) | $ 153 billion | $ 12 billion
Google (GOOG) | $ 140 billion | $ 10 billion
Intel (INTC) | $ 110 billion | $ 12 billion
Amazon (AMZN) | $ 89 billion | $ 1 billion
HP (HPQ) | $ 84 billion | $ 9 billion
Cisco (CSCO) | $ 59 billion | $ 8 billion
Other than the outlier Amazon with its 89x earnings multiple, none of these businesses sell for more than 14x earnings with several still having single digit multiples.
So, with the exception of Amazon, all of the above companies have substantial amounts of earning power to support the sizable valuations.
At this time not much is known about Facebook's financials. This New York Times article from earlier this year said Facebook's revenue was approximately $ 2 billion and had ~ $ 400 million of profit. The year earlier, revenue was more like $ 770 million with profits more like $ 220 million.
A slightly more optimistic take came from this Business Insider article. It claims that fourth quarter 2010 earnings for Facebook was more like $ 250 million with full year 2010 earnings coming in at around $ 600 million.
The article added that Facebook's 2011 projected financial performance is on pace for $ 2 billion of EBITDA (earnings before interest, taxes, depreciation, and amortization) with revenue more than $ 4 billion.
So it looks like Facebook could easily end up with net income well north of the $ 1 billion level in 2011. Spectacular growth but it's still off of a relatively small base. We'll all have better access to financial information on Facebook once the S-1 comes out as the IPO approaches.
The article added that Facebook's 2011 projected financial performance is on pace for $ 2 billion of EBITDA (earnings before interest, taxes, depreciation, and amortization) with revenue more than $ 4 billion.
So it looks like Facebook could easily end up with net income well north of the $ 1 billion level in 2011. Spectacular growth but it's still off of a relatively small base. We'll all have better access to financial information on Facebook once the S-1 comes out as the IPO approaches.
Most companies when they go public do not start out as a large cap stock but it looks like Facebook's going to be the exception.
At $ 100 billion, Facebook will have nearly 4x the market valuation that Google had when it went public in 2004.
* Enterprise Value = Market Capitalization - Net Cash
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, July 13, 2011
Buffett Invests $ 4 Billion in Equities
Late last week, Warren Buffett was interviewed by Bloomberg.
In this Bloomberg article Buffett says they've spent something like $ 4 billion on equities since February.
Bloomberg Video: Interview With Warren Buffett
Buffett received a bunch of coverage earlier this year when, in the annual letter to shareholders, he said that the "elephant gun has been reloaded, and my trigger finger is itchy". He was referring to a future large acquisition which he shortly thereafter delivered on with the $9 billion acquisition of Lubrizol. The admission now that $4 billion has already been invested in common stocks this year reveals he clearly wanted to put some more of that cash on the balance sheet to work.
Berkshire Hathaway's (BRKa) two largest equity investments remain soft drink maker, Coca-Cola Co. (KO), and the largest U.S. home lender, Wells Fargo (WFC). Buffett has added substantially to the Wells position in the past five years or so. In fact, many of the purchases were at higher prices that Wells is selling at now.
The number of Coca-Cola shares that Berkshire owns has not changed for a very long time.
Here's a quick summary of Berkshire's top ten U.S. holdings as of the end of 1Q 2011.
Berkshire's Largest U.S. Holdings
Coca-Cola (KO): $ 13.5 billion
Wells Fargo (WFC): $ 9.3 billion
American Express (AXP): 7.4 billion
Procter & Gamble (PG): 4.9 billion
Kraft (KFT): $ 3.7 billion
Johnson & Johnson (JNJ): $ 2.8 billion
Conoco Phillips (COP): $ 2.2 billion
Wal-Mart (WMT): $ 2.1 billion
US Bancorp (USB): $ 1.7 billion
Moody's (MCO): $ 1.0 billion
In addition to these holdings, other large non-U.S. holdings* include Munich Re, Sanofi-Aventis (SNY), Posco (PKX), Tesco (TSCDY), and BYD.
What Buffett has been doing when it comes to common stocks in 2011 is a shift compared to last year. In 2010, Buffett actually sold more equities than he purchased. In fact, last year Berkshire purchased $ 4.3 billion in equities while selling roughly $ 5.9 billion.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, KFT, JNJ, COP, WMT, USB, MCO, SNY, and PKX
* Berkshire owns a small amount of Sanofi's ADR but most of the shares are not in the form of ADR's.
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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.
In this Bloomberg article Buffett says they've spent something like $ 4 billion on equities since February.
Bloomberg Video: Interview With Warren Buffett
Buffett received a bunch of coverage earlier this year when, in the annual letter to shareholders, he said that the "elephant gun has been reloaded, and my trigger finger is itchy". He was referring to a future large acquisition which he shortly thereafter delivered on with the $9 billion acquisition of Lubrizol. The admission now that $4 billion has already been invested in common stocks this year reveals he clearly wanted to put some more of that cash on the balance sheet to work.
Berkshire Hathaway's (BRKa) two largest equity investments remain soft drink maker, Coca-Cola Co. (KO), and the largest U.S. home lender, Wells Fargo (WFC). Buffett has added substantially to the Wells position in the past five years or so. In fact, many of the purchases were at higher prices that Wells is selling at now.
The number of Coca-Cola shares that Berkshire owns has not changed for a very long time.
Here's a quick summary of Berkshire's top ten U.S. holdings as of the end of 1Q 2011.
Berkshire's Largest U.S. Holdings
Coca-Cola (KO): $ 13.5 billion
Wells Fargo (WFC): $ 9.3 billion
American Express (AXP): 7.4 billion
Procter & Gamble (PG): 4.9 billion
Kraft (KFT): $ 3.7 billion
Johnson & Johnson (JNJ): $ 2.8 billion
Conoco Phillips (COP): $ 2.2 billion
Wal-Mart (WMT): $ 2.1 billion
US Bancorp (USB): $ 1.7 billion
Moody's (MCO): $ 1.0 billion
In addition to these holdings, other large non-U.S. holdings* include Munich Re, Sanofi-Aventis (SNY), Posco (PKX), Tesco (TSCDY), and BYD.
What Buffett has been doing when it comes to common stocks in 2011 is a shift compared to last year. In 2010, Buffett actually sold more equities than he purchased. In fact, last year Berkshire purchased $ 4.3 billion in equities while selling roughly $ 5.9 billion.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, KFT, JNJ, COP, WMT, USB, MCO, SNY, and PKX
* Berkshire owns a small amount of Sanofi's ADR but most of the shares are not in the form of ADR's.
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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.
Tuesday, July 12, 2011
Selling Wal-Mart Back to the Walton Family: Part 2
A follow up to this post and a further look at how Wal-Mart (WMT) compares to Amazon.com (AMZN).
Selling Wal-Mart Back to the Walton Family: Part 1
Well, which of the two options below seems the better deal?
Selling Wal-Mart Back to the Walton Family: Part 1
Wal-Mart currently sells at roughly 12x current-year earnings. These days, that's not actually all that unusual as their many large cap quality franchises selling at or near similar recent valuations.
Last year, Wal-Mart earned $ 16.4 billion.
Amazon earned $ 1.15 billion.
More than 14x more in current earnings power.
Amazon earned $ 1.15 billion.
More than 14x more in current earnings power.
So Wal-Mart earns every 3.5 weeks or so what Amazon earns in a year.
That comparison, in itself, of course doesn't reveal a whole lot. Wal-Mart's business could, as some seem to believe, stagnate while Amazon's business economics may eventually improve after they get past the heavy investments in the business they are making.
That comparison, in itself, of course doesn't reveal a whole lot. Wal-Mart's business could, as some seem to believe, stagnate while Amazon's business economics may eventually improve after they get past the heavy investments in the business they are making.
Somewhat surprisingly, the gap in absolute earnings between Wal-Mart and Amazon has actually increased in recent years. For the two years ended fiscal year 2010, Wal-Mart added ~$ 3.0 billion to its annualized earnings run rate by while Amazon added $ 407 million. Though, of course, Amazon grew earnings faster in percentage terms off of its rather smallish earnings base.
Unfortunately, Amazon has anything but a smallish market value. Its value is now close to $ 100 billion compared to Wal-Mart's $ 185 billion.
We know that Wal-Mart is earning 14x more each year but some say the superior long-term growth prospects of Amazon justifies that stock's premium valuation.
Well, which of the two options below seems the better deal?
Option 1: $ 100 billion that buys $ 407 million in cumulative 2 yr earnings growth, a current $ 1.15 billion earnings run rate and a seemingly, at least today, great long-term growth story.
or
Option 2: $ 185 billion buys $ 3.0 billion in cumulative 2 yr earnings growth, a $ 16.4 billion earnings run rate and, I guess, a not so great story. (As an investor, I happen to like boring stories like Wal-Mart.)
Since I can't spend percentages or stories I'll take option 2. For less than 2x the price I get vastly superior economics and not much good has to happen to make very healthy long-term returns. In contrast, many good things have to happen to Amazon just to support its valuation.
Wal-Mart is cheaper compared to current earnings and the growth in its dollar, if not percentage, earnings. The above, in part, explains why a high earnings multiple paid for impressive percentage growth frequently does not work out in the long run for an investor. There are exceptions, of course, but odds are the investor is more exposed to the possibility permanent capital loss, or, at least subpar performance at higher than necessary risk.
Wal-Mart is cheaper compared to current earnings and the growth in its dollar, if not percentage, earnings. The above, in part, explains why a high earnings multiple paid for impressive percentage growth frequently does not work out in the long run for an investor. There are exceptions, of course, but odds are the investor is more exposed to the possibility permanent capital loss, or, at least subpar performance at higher than necessary risk.
I realize others, for a variety of reasons, will no doubt still prefer Option 1. If Amazon somehow maintains that percentage growth rate even as it becomes a much larger business then eventually the valuation would make sense. That's a tough sell (at least for my money) on a risk-adjusted basis.
Wal-Mart doesn't have to grow much, if at all, to make investors a nice return. In fact, at current prices nothing spectacular has to happen for investors to do well. In recent years, the company has been consistently buying back its stock below intrinsic value. As I noted in the previous post, Michael Santoli's article in Barron's points out investors are effectively selling Wal-Mart back to the Walton family.*
On the other hand, at current prices Amazon needs to be spectacular as a business just to produce a decent return for investors. You can be sure that if Amazon doesn't continue to grow rapidly and for a very long time the returns will be less than satisfactory.
It's worth noting that very overvalued stocks tend to get even more overvalued so I have no trouble believing Amazon's share price will go even higher from here. For those that want to trade price action I'm sure it could work out just fine.
Who knows, but as an informed speculative bet, it might just work.
Wal-Mart doesn't have to grow much, if at all, to make investors a nice return. In fact, at current prices nothing spectacular has to happen for investors to do well. In recent years, the company has been consistently buying back its stock below intrinsic value. As I noted in the previous post, Michael Santoli's article in Barron's points out investors are effectively selling Wal-Mart back to the Walton family.*
On the other hand, at current prices Amazon needs to be spectacular as a business just to produce a decent return for investors. You can be sure that if Amazon doesn't continue to grow rapidly and for a very long time the returns will be less than satisfactory.
It's worth noting that very overvalued stocks tend to get even more overvalued so I have no trouble believing Amazon's share price will go even higher from here. For those that want to trade price action I'm sure it could work out just fine.
Who knows, but as an informed speculative bet, it might just work.
For long-term investors it's different story. Amazon has what looks like a very good business. Someday, the company will probably even justify its valuation (and much more).
Yet, an investor doesn't (or, at least, shouldn't) put money at risk just so something may justify its valuation (or even 2-3x its valuation) someday.
It is also quite possible that Amazon will end up being worth more than Wal-Mart someday. Even in that optimistic scenario, when fully considering the time it will likely take to become intrinsically worth that much, the shares, at least near the current valuation, still aren't likely to produce satisfactory risk-adjusted returns.
It is also quite possible that Amazon will end up being worth more than Wal-Mart someday. Even in that optimistic scenario, when fully considering the time it will likely take to become intrinsically worth that much, the shares, at least near the current valuation, still aren't likely to produce satisfactory risk-adjusted returns.
The question for an investor always comes down to a judgment along the following lines:
At the price paid, how does the long run likely returns versus risks compare to other investing alternatives.
At the price paid, how does the long run likely returns versus risks compare to other investing alternatives.
On that score I don't think Amazon works.
I think an investor can quite easily get similar or more attractive long-term returns with more certainty and less downside elsewhere.
I think an investor can quite easily get similar or more attractive long-term returns with more certainty and less downside elsewhere.
Adam
Long position in Wal-Mart
* Shares outstanding has gone from 4.48 billion to 3.51 billion for Wal-Mart (~ 21% reduction) and from 364 million to 459 million for Amazon (~ 26% increase) over ten years. Those buybacks below intrinsic value enhance long-term returns in a not insignificant way over time. They also serve to limit the downside. This assumes that the company is financially strong, has no other strategic need for corporate cash, and the necessary investments are being made that maintain, or ideally enhance, the size and strength of its economic moat.
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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.
Long position in Wal-Mart
* Shares outstanding has gone from 4.48 billion to 3.51 billion for Wal-Mart (~ 21% reduction) and from 364 million to 459 million for Amazon (~ 26% increase) over ten years. Those buybacks below intrinsic value enhance long-term returns in a not insignificant way over time. They also serve to limit the downside. This assumes that the company is financially strong, has no other strategic need for corporate cash, and the necessary investments are being made that maintain, or ideally enhance, the size and strength of its economic moat.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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