Jeff Auxier, manager of the Auxier Focus Fund (AUXFX), was interviewed a few months back by GuruFocus.
From the interview:
"I like products that people buy frequently that are lower ticket, especially in tough economic times. The global population recently surpassed 7 billion. Most people just want to get through their day with a little pleasure. They want a cup of coffee, a bite of chocolate, a cigarette, a beer, a Coke, whatever, a little boost to get them through. So we like the fact that people are going to buy that product every day, by their choice."
Some of the best businesses in the world sell the stuff that's consumed everyday by the global middle class (according to Auxier the global middle class is ~1.8 billion and growing by ~150 million/year). Things like snacks, beverages, tobacco, and other lower ticket branded consumer products. Compared to just about anything else, many of the great global franchises have very significant and durable competitive advantages. As a result, the best among them tend to have relatively predictable, attractive long-term business economics and prospects. More from the interview:
"Recently throughout Asia and China, there is a movement away from the cheap knockoffs and a push for higher quality, especially with regard to food. They want the real thing. People want to buy quality Western brands. The disclosure provided by the internet is driving envy. People want to live better. I look at what people are using by their choice, what they like to do every day, and that source of demand. We have $400 billion a year in housing subsidies. How do you figure out the real supply demand there? Russians are going crazy over Doritos because they love the taste."
And big scale matters...
"If you look at the demographics related to food in Asia – the rapid urbanization – the thing is you need scale to hit that market. You can't do it as a small company."
Basically, the producers of things like snacks, beverages, and cigarettes with some scale are the exact opposite of technology businesses.
The difficulty with most tech companies isn't understanding what their business economics look like now.
The problem is understanding what those economics will look like in 10 or 20 years.
Not an easy thing to do. Tech businesses reside in environments that are fast changing and unpredictable. There is a wide range of possible outcomes and, as a result, they require a much larger margin of safety.
Mostly, they are not worth the trouble unless extremely cheap to protect against the worst possible outcomes. With technology businesses, too often the storm clouds don't emerge with enough warning. Cheap is often not cheap enough. I realize some are very good at identifying the next big winner in technology, but that's a tough thing to do consistently well. Besides, potential big winners often reside in the same neighborhood as potential big losers and sometimes they're difficult to tell apart.
Avoid the big losses and the returns usually follow.
As I explained here and on other occasions, there's just no technology business that I'm comfortable with as a long-term investment. Most are involved in exciting, dynamic, and highly competitive industries.
That's precisely what makes them unattractive long-term investments.
No matter how good business looks today (or how high the expectations are), it's just not that easy to predict their economic prospects many years from now.
With the best businesses that's not the case. Occasionally, certain tech stocks have sold at enough of a discount that it made me willing to own some shares. Even then I'm only willing to slowly accumulate very limited amounts. They've always been and always will be, at most, very small positions. To be worth the bother, the shares must sell at an extremely low multiple of free cash flow and, even if lacking growth prospects, have cash generating capabilities unlikely to fall off a cliff.*
In other words, I'm not exactly trying to anticipate the next big thing in tech. I'll let others try to figure that sort of thing out. It's buying inexpensive cash flow and, in some cases, lots of net cash on the balance sheet. Cash that, even if not put to brilliant use, just needs to not be allocated in very dumb ways. (Though it's better to assume that some poor capital allocation will happen then end up pleasantly surprised. The price paid should reflect that assumption.) The margin of safety must be large enough that nothing great has to happen to get, over several years, a good investment result. It must also be substantial enough to protect against all but the very worst unforeseeable rather bad tech business outcomes.
Tech businesses, in general, are involved in exciting, dynamic, and highly competitive businesses. That's precisely what makes them unattractive long-term investments.
I'd buy more shares of my favorite businesses (some are in Stocks to Watch and the Six Stock Portfolio), with the intent to hold them indefinitely, if they were selling at just a nice (but not extreme) discount to intrinsic value. In contrast, even if bought extremely cheap, most tech stocks are just not for the long haul in my view.**
So, if there's a very large margin of safety, I'll consider some limited technology exposure but that's it. Well, at least until that margin of safety shrinks a bit. In general, they'll always play a small supporting role.
Jeff Auxier later added this in the interview:
"If the food dynamics are growing 2 to 3 times faster than the economy, who's going to do it? It's going to be like a Tesco, and a Pepsi and a Wal-Mart."
The portfolio he manages is certainly consistent with his thinking.
Here's the top ten positions in the Auxier Focus Fund:
PepsiCo (PEP)
Molson Coors (TAP)
Tesco PLC (TSCDY)
Philip Morris International (PM)
Merck (MRK)
Microsoft (MSFT)
Procter & Gamble (PG)
Wal-Mart (WMT)
Medtronic (MDT)
Hospira (HSP)
According to Morningstar the annual portfolio turnover is 8%. So what's in the portfolio is generally held for quite a while. The top 10 make up roughly 21% of the portfolio.
The problem is getting shares of the great franchises when they're truly cheap. Unfortunately, it happens too rarely and most are not at all inexpensive right now.
In fact, the financial crisis provided the first window in quite a while to buy shares of the best businesses at big discounts to intrinsic value (conservatively estimated). These days, most of them are much tougher to buy. They remain fine businesses but there's, by definition, lower returns at more risk if bought at these higher prices.
Unfortunately, the window that opened -- as a result of the financial crisis -- to buy shares of higher quality businesses at very attractive valuations has mostly closed.
Check out part I and part II of the interview.
Adam
Long positions in PEP, PM, MSFT, PG, and WMT established at lower prices (in some cases much lower). Also, very small long position in TSCDY.
* Though I actually do prefer that the share price falls even further in the short-to-medium term. That way the cash generating abilities can be used to buyback shares at an increasingly large discount to value. I'm perfectly happy to see a stock I've already bought temporarily go down further if I think management will use the opportunity buyback in a smart way.
** I rarely invest in anything -- and that includes tech stocks -- unless I'm willing to own the shares for several years or even longer. Frequent traders might consider several years to be long-term, but I consider that time frame really the bare minimum for almost any investment. The difficulties that have caused a security to be cheap and mispriced are unlikely to be sorted out in less time than that (though I realize several years is hardly a trade). To me, a long-term investment is something that can be owned indefinitely and deliver good results. (Indefinitely, unless there's damage to the economic moat, valuation become extreme on the high side, or opportunity costs are high.)
Generally speaking, that's just not possible with tech stocks.
So investing in tech stocks is a much different investing model than what I traditionally favor but worth the trouble if the mispricing is substantial. My preferred investing model is to own shares of good businesses indefinitely. Even when bought at just a fair price, the high quality enterprises tend to produce very satisfactory long-term returns with much less risk of permanent loss of capital.
---
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, November 30, 2012
Tuesday, November 27, 2012
Jeremy Grantham's 3Q 2012 Letter: The Decline in U.S. Net Capital Formation
From Jeremy Grantham's latest letter:
"Typically I see less significance than others in debt and monetary factors and more in real factors. When someone says that China is building its trains and houses on debt I think, "No, they are built by real people with real bricks, cement, and steel and whatever happens to the debt, these assets will still be there." (They may fall down but that's a separate story; you can build a bad high rise with or without debt). So I take the quality and quantity of capital and people very seriously: they are the keys to growth and a healthy economy. A badly trained, badly educated workforce is a problem...but reduced, abnormally low capital investment, particularly in the U.S., is the current topic."
Grantham sees the emergence of the "Bonus Culture" as a contributor to the problem (check out the letter for Grantham's explanation) of reduced capital investment. He later added:
"When I was a young analyst, companies like International Paper and International Harvester would drive us all crazy, for just as the supply/demand situation was getting tight and fat profits seemed around the corner, they and their competitors would all build new plants and everyone would drown in excess capacity. The CEOs were all obsessed with market share and would throw capital spending at everything. It might not have been the way to maximize an individual company's profit but it was great for jobs and growth. Now, in the bonus culture, new capacity is regarded with great suspicion. It tends to lower profitability in the near term and, occasionally these days, exposes the investing company to a raider. It is far safer to hold tight to the money and, when the stock needs a little push, buy some of your own stock back. This is going on today as I write, and on a big scale (approximately $500 billion this year). Do this enough, though, and we will begin to see disappointing top-line revenues and a slower growing general economy, such as we may be seeing right now."
In my view, the buybacks themselves aren't a problem, they're a symptom. As a shareholder of a good business, I'm enthusiastic about buybacks when the stock is cheap. When done the right way for the right reasons, buybacks are an important part of disciplined capital allocation.
(Unfortunately, they're frequently executed with too little discipline.)
Still, Grantham is very right that buybacks require capital that could be put to work elsewhere. For increased economic activity to occur, healthy capital investment is needed to fund good ideas and build useful things. Why, in the current environment, are buybacks the more attractive alternative for so many companies? It's worth understanding the real reasons. Maybe the "Bonus Culture" is a contributor to the problem, but I doubt it comes down to just one thing.* I'm guessing there are many reasons companies are choosing buybacks over other capital investments that might lead to economic expansion.
Understanding the root cause(s) of this might not be an easy thing to do, but incredibly important. Even if a business is not buying back stock, it may just hunker down, remain conservative with its capital expenditures, and avoid other forms of risk until there's more certainty.
Compared to historical norms, we are no where near a healthy level of capital formation. Exhibit 5 in Grantham's letter (see page 8) shows this. Check it out. The chart in that exhibit reveals capital formation as a percent of GDP at levels compared to U.S. historical norms that should make no one comfortable.**
Of course, it's not just how much but how smart the investments end up being. It's, as Grantham says, both "the quality and quantity of capital" that matters, but going from where capital formation was a bit more than 50 years ago to where it's at now can hardly be seen as a good thing.
You'll have a hard time convincing me this can't be fixed once it's more fully understood with some smart policy moves and changes to the system. I'm guessing that increased certainty and confidence will eventually lead to more healthy levels of capital formation and investment.
One can only hope that the best ideas will be considered carefully and turned into action.
There's plenty of capital sitting on the sidelines that eventually can be put to good use.
Adam
* Though increased certainty/confidence for businesses and consumers might be cheapest form of economic stimulus.
** Though no measure is perfect, Fixed Private Investment (FPI) as a percent of GDP, points to a similar dynamic. The following chart shows how FPI as a percent of GDP has looked in the U.S. since 1947:
Based upon that chart, it sure looks as if FPI/GDP was closer to the historic average, it would materially improve recent U.S. GDP growth.
---
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.
"Typically I see less significance than others in debt and monetary factors and more in real factors. When someone says that China is building its trains and houses on debt I think, "No, they are built by real people with real bricks, cement, and steel and whatever happens to the debt, these assets will still be there." (They may fall down but that's a separate story; you can build a bad high rise with or without debt). So I take the quality and quantity of capital and people very seriously: they are the keys to growth and a healthy economy. A badly trained, badly educated workforce is a problem...but reduced, abnormally low capital investment, particularly in the U.S., is the current topic."
Grantham sees the emergence of the "Bonus Culture" as a contributor to the problem (check out the letter for Grantham's explanation) of reduced capital investment. He later added:
"When I was a young analyst, companies like International Paper and International Harvester would drive us all crazy, for just as the supply/demand situation was getting tight and fat profits seemed around the corner, they and their competitors would all build new plants and everyone would drown in excess capacity. The CEOs were all obsessed with market share and would throw capital spending at everything. It might not have been the way to maximize an individual company's profit but it was great for jobs and growth. Now, in the bonus culture, new capacity is regarded with great suspicion. It tends to lower profitability in the near term and, occasionally these days, exposes the investing company to a raider. It is far safer to hold tight to the money and, when the stock needs a little push, buy some of your own stock back. This is going on today as I write, and on a big scale (approximately $500 billion this year). Do this enough, though, and we will begin to see disappointing top-line revenues and a slower growing general economy, such as we may be seeing right now."
In my view, the buybacks themselves aren't a problem, they're a symptom. As a shareholder of a good business, I'm enthusiastic about buybacks when the stock is cheap. When done the right way for the right reasons, buybacks are an important part of disciplined capital allocation.
(Unfortunately, they're frequently executed with too little discipline.)
Still, Grantham is very right that buybacks require capital that could be put to work elsewhere. For increased economic activity to occur, healthy capital investment is needed to fund good ideas and build useful things. Why, in the current environment, are buybacks the more attractive alternative for so many companies? It's worth understanding the real reasons. Maybe the "Bonus Culture" is a contributor to the problem, but I doubt it comes down to just one thing.* I'm guessing there are many reasons companies are choosing buybacks over other capital investments that might lead to economic expansion.
Understanding the root cause(s) of this might not be an easy thing to do, but incredibly important. Even if a business is not buying back stock, it may just hunker down, remain conservative with its capital expenditures, and avoid other forms of risk until there's more certainty.
Compared to historical norms, we are no where near a healthy level of capital formation. Exhibit 5 in Grantham's letter (see page 8) shows this. Check it out. The chart in that exhibit reveals capital formation as a percent of GDP at levels compared to U.S. historical norms that should make no one comfortable.**
You'll have a hard time convincing me this can't be fixed once it's more fully understood with some smart policy moves and changes to the system. I'm guessing that increased certainty and confidence will eventually lead to more healthy levels of capital formation and investment.
One can only hope that the best ideas will be considered carefully and turned into action.
There's plenty of capital sitting on the sidelines that eventually can be put to good use.
Adam
* Though increased certainty/confidence for businesses and consumers might be cheapest form of economic stimulus.
** Though no measure is perfect, Fixed Private Investment (FPI) as a percent of GDP, points to a similar dynamic. The following chart shows how FPI as a percent of GDP has looked in the U.S. since 1947:
Based upon that chart, it sure looks as if FPI/GDP was closer to the historic average, it would materially improve recent U.S. GDP growth.
---
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, November 23, 2012
John Bogle: "The Silence of the Funds"
John Bogle had the following to say in this Morningstar interview:
"I am appalled by what has happened in our industry."
Here's why. Bogle says that back when he was doing his Princeton thesis in 1951, the mutual fund industry owned a small percentage of stocks. Now, mutual funds are the biggest owner of stocks. In fact, according to Bogle, large institutional money managers of all kinds now own about 66% of stock.
"...a big turnaround over the last half century. And they are silent."
Bogle has a chapter with the title "The Silence of the Funds" in his new book The Clash of the Cultures.
In the interview, he also said this about Benjamin Graham:
"...in his first book, about a third of that book was dedicated to the role of stockholders and corporate governance, and it's hard to find a word about that in any other book, except, of course, the Bogle books.
But we have a responsibility. We have the rights of corporate ownership; we better exercise the responsibilities of corporate ownership. There is a lot at stake here because the corporations have the same agency problem and those managers want to put their interests before those of their shareholders. I mean this is not black and white, I can see that. But they get too much room to run without any oversight, and you always need oversight. And if the shareholders want the best oversight, the government can only do so much, regulatory bodies can only do so much."
Bogle adds that owners could do much more yet, for a variety of reasons, simply do not. The largest institutions are certainly in the best position to do so considering all the stock that they now own.
In the interview, he talks about some of the reasons why they do not but, to me, a good bit of this comes down to the increasingly short-term focus by participants in the capital markets. Fewer long-term shareholders. More interest in near-term price action. When, in general, a large proportion of participants do not intend to own pieces of a business -- shares of stock -- for very long, it's likely they'll expend far less time and energy carefully thinking about long-term effects and outcomes. Unlikely they'll put much into assuring that responsible governance is in place. Certainly less than a true long-term owner.
(Consider how the average person tends to treat a rental car versus a car they own. Well, maybe too many of our corporations are receiving what's equivalent to the "rental car" treatment.)
In this part of the interview, Bogle points out that the average turnover of a mutual fund portfolio is nearly 100 percent.
"...and that means they hold the average stock for one year. That is unequivocally speculation, and it costs money."*
Those frictional costs are very real. Yet the "silence", as Bogle describes it, by large institutional money managers (those who control roughly 66% of the stock) may actually be far more expensive even if in difficult to measure ways.
Adam
* Unlike the expense ratio of a fund, Bogle points out the costs of all that turnover is not disclosed. He estimates these costs at .5% to 1% per year.
Morningstar Bogle Interview on Corporate Governance & Oversight
Morningstar Bogle Interview on Stewardship
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"I am appalled by what has happened in our industry."
Here's why. Bogle says that back when he was doing his Princeton thesis in 1951, the mutual fund industry owned a small percentage of stocks. Now, mutual funds are the biggest owner of stocks. In fact, according to Bogle, large institutional money managers of all kinds now own about 66% of stock.
"...a big turnaround over the last half century. And they are silent."
Bogle has a chapter with the title "The Silence of the Funds" in his new book The Clash of the Cultures.
In the interview, he also said this about Benjamin Graham:
"...in his first book, about a third of that book was dedicated to the role of stockholders and corporate governance, and it's hard to find a word about that in any other book, except, of course, the Bogle books.
But we have a responsibility. We have the rights of corporate ownership; we better exercise the responsibilities of corporate ownership. There is a lot at stake here because the corporations have the same agency problem and those managers want to put their interests before those of their shareholders. I mean this is not black and white, I can see that. But they get too much room to run without any oversight, and you always need oversight. And if the shareholders want the best oversight, the government can only do so much, regulatory bodies can only do so much."
Bogle adds that owners could do much more yet, for a variety of reasons, simply do not. The largest institutions are certainly in the best position to do so considering all the stock that they now own.
In the interview, he talks about some of the reasons why they do not but, to me, a good bit of this comes down to the increasingly short-term focus by participants in the capital markets. Fewer long-term shareholders. More interest in near-term price action. When, in general, a large proportion of participants do not intend to own pieces of a business -- shares of stock -- for very long, it's likely they'll expend far less time and energy carefully thinking about long-term effects and outcomes. Unlikely they'll put much into assuring that responsible governance is in place. Certainly less than a true long-term owner.
(Consider how the average person tends to treat a rental car versus a car they own. Well, maybe too many of our corporations are receiving what's equivalent to the "rental car" treatment.)
In this part of the interview, Bogle points out that the average turnover of a mutual fund portfolio is nearly 100 percent.
"...and that means they hold the average stock for one year. That is unequivocally speculation, and it costs money."*
Those frictional costs are very real. Yet the "silence", as Bogle describes it, by large institutional money managers (those who control roughly 66% of the stock) may actually be far more expensive even if in difficult to measure ways.
Adam
* Unlike the expense ratio of a fund, Bogle points out the costs of all that turnover is not disclosed. He estimates these costs at .5% to 1% per year.
Morningstar Bogle Interview on Corporate Governance & Oversight
Morningstar Bogle Interview on Stewardship
---
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, November 19, 2012
Buffett on Teledyne's Henry Singleton
From this recent CNBC interview with Warren Buffett:
"...we mostly buy stocks for future earnings. And if they use the money to...repurchase shares like Henry Singleton did with Teledyne years ago, that could be even more advantageous."
Earlier this year, Singleton's approach with Teledyne (now Teledyne Technologies: TDY) was summarized in this Bloomberg article:
"...Henry Singleton, made acquisitions using the company's stock when its price was high. When the share price went down, Singleton bought back shares repeatedly."
The article not only mentions the 23 percent annual return that Singleton's skilled management and capital deployment produced over two decades, it also mentions a letter that Buffett wrote to Leon Cooperman congratulating him for his analysis of the stock.
(Cooperman liked the stock in 1968 before it went on to produce those impressive returns. That letter is apparently framed and displayed in his office.)
According to John Train's book The Money Masters, Buffett once said the following about Singleton:
"Henry Singleton of Teledyne has the best operating and capital deployment record in American business."
Another good excerpt from Train's book:
"According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime, he says. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter."
In the CNBC interview, Buffett used IBM [IBM] as a recent example of effective share repurchases.
"IBM [IBM] spent 3 billion in each quarter this year, almost to the dollar, buying in stock. The cheaper they buy it, the more our interest goes up."
Buffett wouldn't be supportive of those IBM buybacks unless he thought the shares were worth intrinsically more.
Now, Henry Singleton wasn't just smart about buying back Teledyne's shares when cheap.
He was also rather savvy about using the company's stock, when pricey, as a currency for acquisitions. If a company's stock selling at 40, 50, or 60 times earnings* is used as a currency to acquire generally sound businesses selling at low earnings multiples, good things seem likely to happen over the long haul.
So intelligent and disciplined buybacks (repurchasing shares when selling for less than per share intrinsic value) is only part of the story.
Unfortunately, Singleton's way of allocating capital isn't always easy to find. Some companies buy back their stock with too little consideration with how the market price compares to value. They'll buy shares when expensive or, at least, not cheap. Worse yet, some later end up even selling shares at lower prices out of necessity.**
(Making an already less than optimal situation for shareholders only worse.)
Singleton used Teledyne's expensive stock to buy other businesses when they were selling at attractive valuations. He'd also buy pieces of businesses -- shares of common stock -- when cheap instead of paying a premium valuation to gain control of an entire public company via a tender offer. Some other corporate leaders might be willing to pursue that kind of expensive growth.
Not Henry Singleton.
From this 1979 Forbes article on Henry Singleton:
"American business is still gripped with a mania for bigness. Companies whose stocks sell for five times earnings will think nothing of going out and paying 10 or 15 times earnings for a nice big acquisition when they could tender for their own stock at half the price. Shrinking -- à la Teledyne -- still isn't done except by a handful of shrewd entrepreneurial companies."
Sounds familiar. That was 1979 but I don't think the dynamics have changed much, if at all, these days. For long-term shareholders, it's increases to per share value, not the total size of the enterprise, that matters.
Why pay a premium valuation to own a company outright when small pieces are selling at attractive valuations? Why pay a premium valuation, for something likely less well understood, if Teledyne's own stock -- the enterprise Singleton would understand best -- was cheap?
To fund expensive acquisitions, companies do forgo the chance to own pieces of a business -- including their own company's shares -- that sell at a low multiple of earnings and, more importantly, nicely below intrinsic value. Instead of buying what's plainly cheap, they figure out a way to justify the premium required to gain control of the target company, often for "strategic" reasons. As is obvious from the excerpt in the Forbes article, a 2 to 3 times higher multiple of earnings wasn't enough to prevent this sort of behavior.***
The justification may sound compelling and, at times, actually even make sense. Unfortunately, too often the premium does not make sense for shareholders.
With disciplined capital deployment, Singleton was able to increase long-term shareholder returns meaningfully. You'd think this way of thinking would become more commonplace. It certainly wasn't the norm during his time. It basically still isn't now.
Mistakes were made along the way, of course, but anyone interested in understanding effective capital allocation and deployment can learn a lot from Singleton's approach.
Plenty of useful lessons that too few business executives or market participants seem to fully appreciate.
Advantage to those who do.
Singleton also didn't mind portfolio concentration and stuck to buying businesses he understood well.
In fact, his approach seems not at all unlike Warren Buffett's way of thinking in a number of ways.
Adam
Related posts:
Why Buffett Wants IBM's Shares "To Languish"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?
Related articles:
The singular Henry Singleton
The Brain Behind Teledyne, A Great American Capitalist
* See page 48 of this Forbes article.
** For a buyback to make sense, not only does the stock need to sell nicely below estimated per share intrinsic value, the company itself needs to also be in a comfortable financial position and have a stable business. (Ideally with predictable and easy to understand sustainable competitive advantages.) Stock shouldn't be bought back if the action could leave the company vulnerable to costly dilution during an economic downturn or a crisis. A company forced to sell shares extremely cheap (its weakened financial position brought on by buying expensive stock when capital seemed easy to come by) may end up diluting continuing shareholders in a way that's quite expensive. Using up capital to buyback expensive shares may also prevent the company from being on offense when the opportunity to buy back cheap shares eventually arises.
*** It's not that certain businesses aren't worth a slight premium. Occasionally, they certainly can be. So some, of course, are worth a bit of a premium valuation but too often there are extreme premiums paid and questionable justifications made. The premium paid might be portrayed as a way to enhance per share value but, in fact, is more about growth of the "business empire" with per share value creation an afterthought. It's some variation of growth for growth's sake. The kind of growth that ends up being expensive or, at least, less than optimal for long-term shareholder returns.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
"...we mostly buy stocks for future earnings. And if they use the money to...repurchase shares like Henry Singleton did with Teledyne years ago, that could be even more advantageous."
Earlier this year, Singleton's approach with Teledyne (now Teledyne Technologies: TDY) was summarized in this Bloomberg article:
"...Henry Singleton, made acquisitions using the company's stock when its price was high. When the share price went down, Singleton bought back shares repeatedly."
The article not only mentions the 23 percent annual return that Singleton's skilled management and capital deployment produced over two decades, it also mentions a letter that Buffett wrote to Leon Cooperman congratulating him for his analysis of the stock.
(Cooperman liked the stock in 1968 before it went on to produce those impressive returns. That letter is apparently framed and displayed in his office.)
According to John Train's book The Money Masters, Buffett once said the following about Singleton:
"Henry Singleton of Teledyne has the best operating and capital deployment record in American business."
Another good excerpt from Train's book:
"According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime, he says. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter."
In the CNBC interview, Buffett used IBM [IBM] as a recent example of effective share repurchases.
"IBM [IBM] spent 3 billion in each quarter this year, almost to the dollar, buying in stock. The cheaper they buy it, the more our interest goes up."
Buffett wouldn't be supportive of those IBM buybacks unless he thought the shares were worth intrinsically more.
Now, Henry Singleton wasn't just smart about buying back Teledyne's shares when cheap.
He was also rather savvy about using the company's stock, when pricey, as a currency for acquisitions. If a company's stock selling at 40, 50, or 60 times earnings* is used as a currency to acquire generally sound businesses selling at low earnings multiples, good things seem likely to happen over the long haul.
So intelligent and disciplined buybacks (repurchasing shares when selling for less than per share intrinsic value) is only part of the story.
Unfortunately, Singleton's way of allocating capital isn't always easy to find. Some companies buy back their stock with too little consideration with how the market price compares to value. They'll buy shares when expensive or, at least, not cheap. Worse yet, some later end up even selling shares at lower prices out of necessity.**
(Making an already less than optimal situation for shareholders only worse.)
Singleton used Teledyne's expensive stock to buy other businesses when they were selling at attractive valuations. He'd also buy pieces of businesses -- shares of common stock -- when cheap instead of paying a premium valuation to gain control of an entire public company via a tender offer. Some other corporate leaders might be willing to pursue that kind of expensive growth.
Not Henry Singleton.
From this 1979 Forbes article on Henry Singleton:
"American business is still gripped with a mania for bigness. Companies whose stocks sell for five times earnings will think nothing of going out and paying 10 or 15 times earnings for a nice big acquisition when they could tender for their own stock at half the price. Shrinking -- à la Teledyne -- still isn't done except by a handful of shrewd entrepreneurial companies."
Sounds familiar. That was 1979 but I don't think the dynamics have changed much, if at all, these days. For long-term shareholders, it's increases to per share value, not the total size of the enterprise, that matters.
Why pay a premium valuation to own a company outright when small pieces are selling at attractive valuations? Why pay a premium valuation, for something likely less well understood, if Teledyne's own stock -- the enterprise Singleton would understand best -- was cheap?
To fund expensive acquisitions, companies do forgo the chance to own pieces of a business -- including their own company's shares -- that sell at a low multiple of earnings and, more importantly, nicely below intrinsic value. Instead of buying what's plainly cheap, they figure out a way to justify the premium required to gain control of the target company, often for "strategic" reasons. As is obvious from the excerpt in the Forbes article, a 2 to 3 times higher multiple of earnings wasn't enough to prevent this sort of behavior.***
The justification may sound compelling and, at times, actually even make sense. Unfortunately, too often the premium does not make sense for shareholders.
With disciplined capital deployment, Singleton was able to increase long-term shareholder returns meaningfully. You'd think this way of thinking would become more commonplace. It certainly wasn't the norm during his time. It basically still isn't now.
Mistakes were made along the way, of course, but anyone interested in understanding effective capital allocation and deployment can learn a lot from Singleton's approach.
Plenty of useful lessons that too few business executives or market participants seem to fully appreciate.
Advantage to those who do.
Singleton also didn't mind portfolio concentration and stuck to buying businesses he understood well.
In fact, his approach seems not at all unlike Warren Buffett's way of thinking in a number of ways.
Adam
Related posts:
Why Buffett Wants IBM's Shares "To Languish"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?
Related articles:
The singular Henry Singleton
The Brain Behind Teledyne, A Great American Capitalist
* See page 48 of this Forbes article.
** For a buyback to make sense, not only does the stock need to sell nicely below estimated per share intrinsic value, the company itself needs to also be in a comfortable financial position and have a stable business. (Ideally with predictable and easy to understand sustainable competitive advantages.) Stock shouldn't be bought back if the action could leave the company vulnerable to costly dilution during an economic downturn or a crisis. A company forced to sell shares extremely cheap (its weakened financial position brought on by buying expensive stock when capital seemed easy to come by) may end up diluting continuing shareholders in a way that's quite expensive. Using up capital to buyback expensive shares may also prevent the company from being on offense when the opportunity to buy back cheap shares eventually arises.
*** It's not that certain businesses aren't worth a slight premium. Occasionally, they certainly can be. So some, of course, are worth a bit of a premium valuation but too often there are extreme premiums paid and questionable justifications made. The premium paid might be portrayed as a way to enhance per share value but, in fact, is more about growth of the "business empire" with per share value creation an afterthought. It's some variation of growth for growth's sake. The kind of growth that ends up being expensive or, at least, less than optimal for long-term shareholder returns.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Thursday, November 15, 2012
Berkshire Hathaway 3rd Quarter 2012 13F-HR
The Berkshire Hathaway (BRKa) 3rd Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 2nd Quarter 2012 13F-HR.)
As I noted in this post last week, Berkshire was a net seller of equities in the most recent quarter. The latest 10-Q made it clear a good portion of the selling was one or more of Berkshire's consumer stocks.
(The clue was the drop in cost basis of Berkshire's consumer products equity securities. See Note 5 of the most recent 10-Q then compare to the prior quarter's 10-Q.)
It just wasn't obvious which specific consumer stock (or stocks).
Well, thanks to this most recent 13F-HR, we now know. In addition to selling almost all of their Johnson & Johnson (JNJ) stake, it turns out nearly half of their shares in Kraft (KFT before spin-off) and, to a lesser extent, Procter & Gamble (PG) were sold.
Those three stocks made up the bulk of the selling but quite a few other sales also happened this past quarter.
Details below.
There was also plenty of stocks being bought during the quarter. Some brand new positions were established while Buffett and his portfolio managers continued to build upon existing positions.
Here's what changed during the 3rd quarter:*
New Positions
Deere & Company ((DE): Bought 3.98 million shares worth $337 million
Precision Castparts (PCP): 1.25 million shares worth $216 million
Wabco Holdings ((WBC): 1.6 million shares worth $92 million
Media General (MEG): 4.6 million shares worth $ 18 million
Added to Existing Positions
Wells Fargo (WFC): Bought 11.5 million shares worth $ 362 million, total stake $ 13.3 billion
IBM (IBM): 872.5 thousand shares worth $ 162 million, total stake $ 12.5 billion
DirecTV (DTV): 1.1 million shares worth $ 54.7 million, total stake $ 1.43 billion
DaVita (DVA): 897.57 thousand shares worth $ 101 million, total stake $ 1.14 billion
BNY Mellon (BK): 914.4 thousand shares worth $ 22 million, total stake $ 462 million
General Motors (GM): 5 million shares worth $ 120 million, total stake $ 363 million
Viacom (VIA-B): 794 thousand shares worth $ 38 million, total stake now $ 365 million
National Oilwell Varco (NOV): 1.34 million shares worth $ 94 million, total stake now $ 291 million
In the 3rd Quarter of 2012, there apparently was nothing purchased that was kept confidential. Berkshire's 13F-HR filings will often say: "Confidential information has been omitted from the Form 13F and filed separately with the Commission."
Not this time. Unlike the prior 13F-HR, all equity transactions have now been disclosed (the buying and selling in the latest 13F-HR then reflects what was actually bought in the 2nd quarter plus what had been held back). From time to time, the SEC allows Berkshire Hathaway to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.
Reduced Positions
Procter & Gamble (PG): Sold 6.8 million shares worth $ 453 million, total stake now $ 3.5 billion
U.S. Bancorp (USB): 4.7 million shares worth $ 148 million, total stake now $ 1.9 billion
Kraft Foods Inc. (KFT before spin-off): 28.4 million shares worth $ 1.2 billion, total stake $ 1.26 billion**
ConocoPhillips (COP): 4.7 million shares worth $ 260 million, total stake now $ 1.3 billion
Visa (V): 524.2 thousand shares worth $ 73.4 million, total stake now $ 218 million
Verisk Analytics (VRSK): 308.44 thousand shares worth $ 15 million, total stake now $ 76 million
Johnson & Johnson (JNJ): 9.8 million shares worth $ 682 million , total stake now $ 34 million
General Electric (GE): 4.4 million shares worth $ 88 million, total stake now $ 12 million
United Parcel Service (UPS): 202.5 thousand shares worth $ 14.2 million, total stake now $ 4.2 million
Lee Enterprises (LEE): 2 million shares worth $ 3.3 million, total stake now $ 1.8 million
Sold Positions
The shares of Ingersoll-Rand (IR), Dollar General (DG), and CVS Caremark (CVS) were sold outright.
Todd Combs and Ted Weschler are responsible for a portion of Berkshire's portfolio. Any changes involving smaller positions will generally be the work of the new portfolio managers. Increasingly, the moves in the portfolio are primarily being done by them.
Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities is made up of ~ 36% financials, 27% consumer goods, 18% technology, and 9% consumer services.
The remainder is primarily spread across healthcare, industrials, and energy.
1. Coca-Cola (KO) = $ 14.4 billion
2. Wells Fargo (WFC) = $ 13.3 billion
3. IBM (IBM) = $ 12.5 billion
4. American Express (AXP) = $ 8.1 billion
5. Procter and Gamble (PG) = $ 3.5 billion
As is almost always the case it's a very concentrated portfolio.
The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S.***, plus cash and cash equivalents, fixed income, and other investments that brings the total portfolio value to somewhere north of $ 175 billion.
The portfolio, of course, excludes all the operating businesses that Berkshire owns outright with 270,000+ employees.
Here are some examples of the non-insurance businesses:
MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking, Lubrizol, and the recently purchased Oriental Trading Company (among others).
In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.
At the end of the quarter, Berkshire's cash and cash equivalents alone was nearly $ 48 billion.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, USB, COP, JNJ, and GE established at lower than recent market prices.
* All values based upon yesterday's closing price with the exception of Kraft. Naturally, what was actually paid can't be known from the information disclosed.
** Based upon closing price prior to spin-off. KFT became MDLZ post spin-off. If no other portfolio moves related to Kraft have been made since the end of the quarter, Berkshire now owns 1 share of KRFT for every 3 MDLZ shares.
*** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Investments in things like preferred shares (and related warrants) are also not included in the 13F-HR.
---
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.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 2nd Quarter 2012 13F-HR.)
As I noted in this post last week, Berkshire was a net seller of equities in the most recent quarter. The latest 10-Q made it clear a good portion of the selling was one or more of Berkshire's consumer stocks.
(The clue was the drop in cost basis of Berkshire's consumer products equity securities. See Note 5 of the most recent 10-Q then compare to the prior quarter's 10-Q.)
It just wasn't obvious which specific consumer stock (or stocks).
Well, thanks to this most recent 13F-HR, we now know. In addition to selling almost all of their Johnson & Johnson (JNJ) stake, it turns out nearly half of their shares in Kraft (KFT before spin-off) and, to a lesser extent, Procter & Gamble (PG) were sold.
Those three stocks made up the bulk of the selling but quite a few other sales also happened this past quarter.
Details below.
There was also plenty of stocks being bought during the quarter. Some brand new positions were established while Buffett and his portfolio managers continued to build upon existing positions.
Here's what changed during the 3rd quarter:*
New Positions
Deere & Company ((DE): Bought 3.98 million shares worth $337 million
Precision Castparts (PCP): 1.25 million shares worth $216 million
Wabco Holdings ((WBC): 1.6 million shares worth $92 million
Media General (MEG): 4.6 million shares worth $ 18 million
Added to Existing Positions
Wells Fargo (WFC): Bought 11.5 million shares worth $ 362 million, total stake $ 13.3 billion
IBM (IBM): 872.5 thousand shares worth $ 162 million, total stake $ 12.5 billion
DirecTV (DTV): 1.1 million shares worth $ 54.7 million, total stake $ 1.43 billion
DaVita (DVA): 897.57 thousand shares worth $ 101 million, total stake $ 1.14 billion
BNY Mellon (BK): 914.4 thousand shares worth $ 22 million, total stake $ 462 million
General Motors (GM): 5 million shares worth $ 120 million, total stake $ 363 million
Viacom (VIA-B): 794 thousand shares worth $ 38 million, total stake now $ 365 million
National Oilwell Varco (NOV): 1.34 million shares worth $ 94 million, total stake now $ 291 million
In the 3rd Quarter of 2012, there apparently was nothing purchased that was kept confidential. Berkshire's 13F-HR filings will often say: "Confidential information has been omitted from the Form 13F and filed separately with the Commission."
Not this time. Unlike the prior 13F-HR, all equity transactions have now been disclosed (the buying and selling in the latest 13F-HR then reflects what was actually bought in the 2nd quarter plus what had been held back). From time to time, the SEC allows Berkshire Hathaway to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.
Reduced Positions
Procter & Gamble (PG): Sold 6.8 million shares worth $ 453 million, total stake now $ 3.5 billion
U.S. Bancorp (USB): 4.7 million shares worth $ 148 million, total stake now $ 1.9 billion
Kraft Foods Inc. (KFT before spin-off): 28.4 million shares worth $ 1.2 billion, total stake $ 1.26 billion**
ConocoPhillips (COP): 4.7 million shares worth $ 260 million, total stake now $ 1.3 billion
Visa (V): 524.2 thousand shares worth $ 73.4 million, total stake now $ 218 million
Verisk Analytics (VRSK): 308.44 thousand shares worth $ 15 million, total stake now $ 76 million
Johnson & Johnson (JNJ): 9.8 million shares worth $ 682 million , total stake now $ 34 million
General Electric (GE): 4.4 million shares worth $ 88 million, total stake now $ 12 million
United Parcel Service (UPS): 202.5 thousand shares worth $ 14.2 million, total stake now $ 4.2 million
Lee Enterprises (LEE): 2 million shares worth $ 3.3 million, total stake now $ 1.8 million
Sold Positions
The shares of Ingersoll-Rand (IR), Dollar General (DG), and CVS Caremark (CVS) were sold outright.
Todd Combs and Ted Weschler are responsible for a portion of Berkshire's portfolio. Any changes involving smaller positions will generally be the work of the new portfolio managers. Increasingly, the moves in the portfolio are primarily being done by them.
Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities is made up of ~ 36% financials, 27% consumer goods, 18% technology, and 9% consumer services.
The remainder is primarily spread across healthcare, industrials, and energy.
1. Coca-Cola (KO) = $ 14.4 billion
2. Wells Fargo (WFC) = $ 13.3 billion
3. IBM (IBM) = $ 12.5 billion
4. American Express (AXP) = $ 8.1 billion
5. Procter and Gamble (PG) = $ 3.5 billion
As is almost always the case it's a very concentrated portfolio.
The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S.***, plus cash and cash equivalents, fixed income, and other investments that brings the total portfolio value to somewhere north of $ 175 billion.
The portfolio, of course, excludes all the operating businesses that Berkshire owns outright with 270,000+ employees.
Here are some examples of the non-insurance businesses:
MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking, Lubrizol, and the recently purchased Oriental Trading Company (among others).
In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.
See page 101 of the annual report for a full list of Berkshire's businesses.
At the end of the quarter, Berkshire's cash and cash equivalents alone was nearly $ 48 billion.
Adam
Long positions in BRKb, KO, WFC, AXP, PG, USB, COP, JNJ, and GE established at lower than recent market prices.
* All values based upon yesterday's closing price with the exception of Kraft. Naturally, what was actually paid can't be known from the information disclosed.
** Based upon closing price prior to spin-off. KFT became MDLZ post spin-off. If no other portfolio moves related to Kraft have been made since the end of the quarter, Berkshire now owns 1 share of KRFT for every 3 MDLZ shares.
*** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Investments in things like preferred shares (and related warrants) are also not included in the 13F-HR.
---
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, November 12, 2012
Nifty Fifty - Part II
A follow up to this post on the Nifty Fifty.
The Nifty Fifty were considered premier growth stocks back in the early 1970s. By late 1972, the valuations of these stocks became quite stretched to say the least.
So what happened if you happened to buy them near the market peak in December of 1972?
Well, in the prior post, I mentioned that the top twenty performers among the Nifty Fifty since the market peak -- from December 1972 through August 1998 -- were dominated by the likes of Philip Morris (now Altria: MO), Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), McDonald's (MCD), Johnson & Johnson (JNJ), and Anheuser-Busch (BUD).
(According to this AAII Journal article written in October 1998 by Professor Jeremy Siegel.)
In fact, out of the top 20 performers, fully 18 of them were either those that sell consumer goods (11) or healthcare (7) businesses.*
(Incidentally, General Electric (GE) and First National City were the two other top twenty performers.)
This despite the fact that most of them were selling at fairly extraordinary P/Es back in December of 1972. Two examples among many:
- J&J's P/E was 57.
- McDonald's P/E was 71.
In 1972, Philip Morris/Altria had a P/E of 24. Not exactly cheap and well above what I'd ever pay.
Yet, by the standards of the early 1970s, it was not expensive.
Among the Nifty Fifty, it had the best annualized returns at 18.8 percent compared to the S&P 500's 12.7 percent over the ~ 26 years.
More than a 6 percent plus annualized performance gap.
In the slightly more than 14 years since the end of that ~ 26 year period, Philip Morris/Altria's annualized total return has been a bit under 15 percent (and now sells at a forward P/E of 14 or so). Over those same 14 plus years, the S&P 500 returned roughly 4.5 percent.**
So Altria has continued to do just fine as far as absolute and relative performance goes. Less than the 18.8 percent, but actually a wider relative performance gap to the S&P 500. Though, of course, what's important is not what a stock has already done, but what it is likely to do over the next twenty or thirty years and its unique risks.
The best performing Nifty Fifty stocks (those that remain publicly traded) likely don't have future prospects that are quite as bright. Many of them remain fine businesses but, as always, the price that gets paid matters. The fact that, after paying a rich multiple, these ended up working out okay in the long run doesn't mean it's a wise way to invest.
Paying high multiples of earning like those prevalent in the Nifty Fifty era -- even for the highest quality shares -- adds plenty of unnecessary risk.
In my view, an investor should always buy shares at a sufficient discount to estimated current intrinsic value. First, estimated value is necessarily imprecise. Second, when investors pay a premium to current value, there's often a lack of downside protection against the unforeseen and unforeseeable. In other words, anyone can look back at how something already did and see that it worked out. In the real world, where judgments need to be made by an investor prospectively, the price paid should always provide a meaningful margin of safety in case things do not go as well as expected.***
To me, paying a price that hopefully will be justified someday seems likely to produce too many unattractive risk-adjusted outcomes in the long run. Better to consistently buy at a plain discount to what a good business is conservatively worth per share today.
These days, few of what remains of the top performing Nifty Fifty, as well as most other so-called "defensive stocks", seem cheap enough (to provide a margin of safety) but at least they do not have the kind of extremely high valuations they've had at times in the past. The window that opened (as a result of the financial crisis) to buy shares of high quality businesses at very attractive valuations has mostly closed.
As I said previously, what's sensible to buy at a discount to intrinsic value doesn't make sense at some materially higher valuation. Margin of safety is always all-important.
Still, it's worth considering this:
"If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
There's no shortage of high P/E stocks in today's market even if they lack a memorable name like the Nifty Fifty. These new high flyers may not have a similarly memorable name, but those who own the current crop of high multiple stocks might want to consider carefully what can be learned from the Nifty Fifty.
Adam
Long MO, KO, PEP, PG, and JNJ
Related posts:
Nifty Fifty - Nov 2012
The Cost of Complexity - Aug 2012
The Quality Enterprise, Part II - Aug 2012
The Quality Enterprise - Aug 2012
Consumer Staples: Long-term Performance, Part II - Dec 2011
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* From December 1972 to August 1998 according to this AAII Journal article written by Professor Jeremy Siegel. It's worth noting that some of these companies are no longer separately traded marketable stocks since, not surprisingly, there have many corporate changes to the Nifty Fifty over the years. Generally, they have either been acquired by other public companies or are now private. The article summarizes all the corporate changes that had occurred up to that point in time.
** Through October 31st, 2012. Excluding taxes, a stock with those kind of annualized returns over 40 years (~ 26 years plus ~ 14 years) compounds in such a way that results in a nearly 600-fold increase in value. Philip Morris International (PM) has separately not done too badly either since the spin-off in 2008. That stock has had roughly 18 percent annualized returns since the spin-off
*** The discount to value should account for the many risks that exist going into an always unpredictable future. The size of the required discount necessarily varies and, for shares of many businesses, no price is cheap enough. Eventually, it's more a go/no go decision and is based upon whether the competitive advantages can be judged, with enough confidence, to be significant and durable.
---
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 Nifty Fifty were considered premier growth stocks back in the early 1970s. By late 1972, the valuations of these stocks became quite stretched to say the least.
So what happened if you happened to buy them near the market peak in December of 1972?
Well, in the prior post, I mentioned that the top twenty performers among the Nifty Fifty since the market peak -- from December 1972 through August 1998 -- were dominated by the likes of Philip Morris (now Altria: MO), Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), McDonald's (MCD), Johnson & Johnson (JNJ), and Anheuser-Busch (BUD).
(According to this AAII Journal article written in October 1998 by Professor Jeremy Siegel.)
In fact, out of the top 20 performers, fully 18 of them were either those that sell consumer goods (11) or healthcare (7) businesses.*
(Incidentally, General Electric (GE) and First National City were the two other top twenty performers.)
This despite the fact that most of them were selling at fairly extraordinary P/Es back in December of 1972. Two examples among many:
- J&J's P/E was 57.
- McDonald's P/E was 71.
In 1972, Philip Morris/Altria had a P/E of 24. Not exactly cheap and well above what I'd ever pay.
Yet, by the standards of the early 1970s, it was not expensive.
Among the Nifty Fifty, it had the best annualized returns at 18.8 percent compared to the S&P 500's 12.7 percent over the ~ 26 years.
More than a 6 percent plus annualized performance gap.
In the slightly more than 14 years since the end of that ~ 26 year period, Philip Morris/Altria's annualized total return has been a bit under 15 percent (and now sells at a forward P/E of 14 or so). Over those same 14 plus years, the S&P 500 returned roughly 4.5 percent.**
So Altria has continued to do just fine as far as absolute and relative performance goes. Less than the 18.8 percent, but actually a wider relative performance gap to the S&P 500. Though, of course, what's important is not what a stock has already done, but what it is likely to do over the next twenty or thirty years and its unique risks.
The best performing Nifty Fifty stocks (those that remain publicly traded) likely don't have future prospects that are quite as bright. Many of them remain fine businesses but, as always, the price that gets paid matters. The fact that, after paying a rich multiple, these ended up working out okay in the long run doesn't mean it's a wise way to invest.
Paying high multiples of earning like those prevalent in the Nifty Fifty era -- even for the highest quality shares -- adds plenty of unnecessary risk.
In my view, an investor should always buy shares at a sufficient discount to estimated current intrinsic value. First, estimated value is necessarily imprecise. Second, when investors pay a premium to current value, there's often a lack of downside protection against the unforeseen and unforeseeable. In other words, anyone can look back at how something already did and see that it worked out. In the real world, where judgments need to be made by an investor prospectively, the price paid should always provide a meaningful margin of safety in case things do not go as well as expected.***
To me, paying a price that hopefully will be justified someday seems likely to produce too many unattractive risk-adjusted outcomes in the long run. Better to consistently buy at a plain discount to what a good business is conservatively worth per share today.
These days, few of what remains of the top performing Nifty Fifty, as well as most other so-called "defensive stocks", seem cheap enough (to provide a margin of safety) but at least they do not have the kind of extremely high valuations they've had at times in the past. The window that opened (as a result of the financial crisis) to buy shares of high quality businesses at very attractive valuations has mostly closed.
As I said previously, what's sensible to buy at a discount to intrinsic value doesn't make sense at some materially higher valuation. Margin of safety is always all-important.
Still, it's worth considering this:
"If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
There's no shortage of high P/E stocks in today's market even if they lack a memorable name like the Nifty Fifty. These new high flyers may not have a similarly memorable name, but those who own the current crop of high multiple stocks might want to consider carefully what can be learned from the Nifty Fifty.
Adam
Long MO, KO, PEP, PG, and JNJ
Related posts:
Nifty Fifty - Nov 2012
The Cost of Complexity - Aug 2012
The Quality Enterprise, Part II - Aug 2012
The Quality Enterprise - Aug 2012
Consumer Staples: Long-term Performance, Part II - Dec 2011
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* From December 1972 to August 1998 according to this AAII Journal article written by Professor Jeremy Siegel. It's worth noting that some of these companies are no longer separately traded marketable stocks since, not surprisingly, there have many corporate changes to the Nifty Fifty over the years. Generally, they have either been acquired by other public companies or are now private. The article summarizes all the corporate changes that had occurred up to that point in time.
** Through October 31st, 2012. Excluding taxes, a stock with those kind of annualized returns over 40 years (~ 26 years plus ~ 14 years) compounds in such a way that results in a nearly 600-fold increase in value. Philip Morris International (PM) has separately not done too badly either since the spin-off in 2008. That stock has had roughly 18 percent annualized returns since the spin-off
*** The discount to value should account for the many risks that exist going into an always unpredictable future. The size of the required discount necessarily varies and, for shares of many businesses, no price is cheap enough. Eventually, it's more a go/no go decision and is based upon whether the competitive advantages can be judged, with enough confidence, to be significant and durable.
---
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, November 8, 2012
Recency Bias and Investor Returns
"People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them." - Warren Buffett in Fortune, December 2001
David Winters is the portfolio manager of the Wintergreen Fund (WGRNX). He was recently interviewed by Consuelo Mack. In the interview, Winters had this to say:
"...people think it's been such a bad period for 10 years that this is going to be forever...and the only way to have made money was, except certain well-selected securities, has been to own bonds. So people now have their money in...Treasury securities."
Winters also makes the point that purchasing power shrinks over time:
"People lose purchasing power on a daily basis. I think inflation is very real. You have food prices going up, fuel prices going up. You need to get your hair done. Prices go up, and if you have your money not growing over time, you get crushed. So here you've got the public believing and institutions believing equities are dead."
Also, Treasury securities may be perceived as safe but, he added:
"We think what's perceived as a risk-free asset is actually an incredibly risky asset."
And finally...
"...if you own the right businesses with a global footprint that grows free cash flow, has a nice yield, those businesses become more valuable over time, and they have the ability not only to raise prices but to sell more units, and so the well-selected equities, which is what we do at Wintergreen Fund to the best of our ability, it protects you from inflation, the erosion of principal which is really, I think, the biggest risk out there."
There's a reliable tendency for investors to be drawn into what has worked recently. In the late 1990s, investors were buying expensive stocks because that's what had been working. These days, investors are drawn into expensive bonds because that's what has been working.
The rear-view mirror is a useful thing to have in an automobile yet no driver can afford to ignore the windshield for very long.
It's no different for investors but, because of recency bias -- the tendency to project recent experiences as if they'll continue into the future -- the equivalent tends to happen. A particular type of asset may seem not risky because of recent performance. Yet, even the highest quality asset that's relatively low risk at one price becomes quite risky (as measured by the possibility of permanent capital loss) when it sells far above its intrinsic value.*
Many stocks sold for 40 times earnings (and, in the case of many tech stocks, much more) in the late 1990s. That's incredibly expensive by any standard and a tough way to get satisfactory risk-adjusted long-term returns on shares of even good businesses (there are exceptions, of course) never mind subpar businesses.
Today, in contrast, it's not tough to find shares of a good business selling for 15 times earnings and even much lower (and, if it's a higher quality business, that stream of earnings should be increasing for many years to come). 15 times earnings may not be extremely cheap but at least it provides a much more favorable environment to buy. Of course, it's certainly possible for the earnings multiple of even the best business to continue contracting. Yet, that's hardly a problem for an owner that has a long horizon. In fact, it's actually a net benefit since the company can use its cash to buy back shares cheap (the same amount of cash reduces the share count by a larger amount directly benefiting the shareholders who hang in there long-term).
If a business has durable advantages, eventually the underlying business economics determines value and the price should, in the long run, at least mostly, if not completely, reflect it. Price action to the downside may feel unsettling but, at least for shares of a good business, it logically shouldn't be. For the long-term part owners of a good business, it's actually quite advantageous when a stock drops even further below what it is intrinsically worth.
The important thing for investors is that the stock is bought below what the business is intrinsically worth per share in the first place (margin of safety).
Now, unlike common stocks, a Treasury security offers the promise of getting your principal back at maturity. Understandably, that's front of mind for many investors considering recent experience in the capital markets, but it's worth considering how recency bias becomes, at times, very detrimental to investor returns. Even just some awareness of this particular cognitive bias can help an investor avoid the costly misjudgments associated with it.
An investor who accepts a 2% yield from a Treasury security is effectively paying 50 times "earnings" (the annual coupon payments). Importantly, unlike a good business, those earnings can't increase in a way that keeps up with inflation.**
Capital preservation is always important but, in the long run, it's going to be tough to maintain purchasing power (never mind increase purchasing power) when an investor pays 50 times or more for an asset that cannot increase the income it produces over time. Sure bonds prices might continue to rise (and yields fall) but compensation for an investor -- at least those with a longer time horizon -- will be likely be inadequate considering the risks. It's less than ideal when returns are dependent on the willingness of other market participants to pay an extreme price. An investor in a pricey bond has to hope someone else will be around to buy it when an attractive alternative investment opportunity comes along.***
Otherwise, it is either take a capital loss or, "best case", forgo the opportunity and collect that inadequate coupon until maturity as purchasing power is eroded year after year by inflation..
In a recent Morningstar interview, John Bogle talks about the trend toward speculation and gambling over investing. In the interview, he point to the late 1990s...
"...where the price of the stock became more important than the intrinsic value of a company. And when you focus on prices and pretty much disregard intrinsic values, you are just gambling."
In contrast, when an investor pays a fair price to own part of a business long-term, they're interested in what the asset can produce over time (the underlying economics that determine intrinsic value), not whether price action happens to go the right way. Since the intrinsic value grows faster than inflation, purchasing power isn't just maintained, it increases.
John Bogle later added just how much this trend has crowded out investing:
"...if you call investment fulfilling the basic function of the financial system, and that is directing capital to its highest and best uses, you're talking about money [that] gets directed in new ventures, existing companies, innovative companies, whatever it might be. And that has been running about $250 billion a year. How do you measure speculation? [You do so] by the amount of trading that goes on in the market, and that's around $33 trillion a year."
The simple math means that 99.2% of what's happening in the market is speculation and .8% is an investment. Consider that the next time someone argues the market needs sufficient liquidity. Speculation is just fine and even desirable but, as with any system, proportion matters. We've got plenty of liquidity. What we need is more actual investing.
Investing to achieve favorable long-term outcomes is rarely easy and naturally has its fair share of risks. Yet, that it is inherently challenging shouldn't lead an investor logically to either speculate on near term price action or hide in Treasury securities.
For those with a long-term horizon, many far more attractive investing alternatives exist.
Adam
* See Berkshire's owner's manual for a useful explanation of intrinsic value.
** 10-year Treasury notes are at 1.67% as I write this. So they currently sell for nearly 60 times the interest paid annually.
*** The same is obviously true with a pricey stock but here the option to just hold to maturity in order to get your principal back doesn't exist.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
David Winters is the portfolio manager of the Wintergreen Fund (WGRNX). He was recently interviewed by Consuelo Mack. In the interview, Winters had this to say:
"...people think it's been such a bad period for 10 years that this is going to be forever...and the only way to have made money was, except certain well-selected securities, has been to own bonds. So people now have their money in...Treasury securities."
Winters also makes the point that purchasing power shrinks over time:
"People lose purchasing power on a daily basis. I think inflation is very real. You have food prices going up, fuel prices going up. You need to get your hair done. Prices go up, and if you have your money not growing over time, you get crushed. So here you've got the public believing and institutions believing equities are dead."
Also, Treasury securities may be perceived as safe but, he added:
"We think what's perceived as a risk-free asset is actually an incredibly risky asset."
And finally...
"...if you own the right businesses with a global footprint that grows free cash flow, has a nice yield, those businesses become more valuable over time, and they have the ability not only to raise prices but to sell more units, and so the well-selected equities, which is what we do at Wintergreen Fund to the best of our ability, it protects you from inflation, the erosion of principal which is really, I think, the biggest risk out there."
There's a reliable tendency for investors to be drawn into what has worked recently. In the late 1990s, investors were buying expensive stocks because that's what had been working. These days, investors are drawn into expensive bonds because that's what has been working.
The rear-view mirror is a useful thing to have in an automobile yet no driver can afford to ignore the windshield for very long.
It's no different for investors but, because of recency bias -- the tendency to project recent experiences as if they'll continue into the future -- the equivalent tends to happen. A particular type of asset may seem not risky because of recent performance. Yet, even the highest quality asset that's relatively low risk at one price becomes quite risky (as measured by the possibility of permanent capital loss) when it sells far above its intrinsic value.*
Many stocks sold for 40 times earnings (and, in the case of many tech stocks, much more) in the late 1990s. That's incredibly expensive by any standard and a tough way to get satisfactory risk-adjusted long-term returns on shares of even good businesses (there are exceptions, of course) never mind subpar businesses.
Today, in contrast, it's not tough to find shares of a good business selling for 15 times earnings and even much lower (and, if it's a higher quality business, that stream of earnings should be increasing for many years to come). 15 times earnings may not be extremely cheap but at least it provides a much more favorable environment to buy. Of course, it's certainly possible for the earnings multiple of even the best business to continue contracting. Yet, that's hardly a problem for an owner that has a long horizon. In fact, it's actually a net benefit since the company can use its cash to buy back shares cheap (the same amount of cash reduces the share count by a larger amount directly benefiting the shareholders who hang in there long-term).
If a business has durable advantages, eventually the underlying business economics determines value and the price should, in the long run, at least mostly, if not completely, reflect it. Price action to the downside may feel unsettling but, at least for shares of a good business, it logically shouldn't be. For the long-term part owners of a good business, it's actually quite advantageous when a stock drops even further below what it is intrinsically worth.
The important thing for investors is that the stock is bought below what the business is intrinsically worth per share in the first place (margin of safety).
Now, unlike common stocks, a Treasury security offers the promise of getting your principal back at maturity. Understandably, that's front of mind for many investors considering recent experience in the capital markets, but it's worth considering how recency bias becomes, at times, very detrimental to investor returns. Even just some awareness of this particular cognitive bias can help an investor avoid the costly misjudgments associated with it.
An investor who accepts a 2% yield from a Treasury security is effectively paying 50 times "earnings" (the annual coupon payments). Importantly, unlike a good business, those earnings can't increase in a way that keeps up with inflation.**
Capital preservation is always important but, in the long run, it's going to be tough to maintain purchasing power (never mind increase purchasing power) when an investor pays 50 times or more for an asset that cannot increase the income it produces over time. Sure bonds prices might continue to rise (and yields fall) but compensation for an investor -- at least those with a longer time horizon -- will be likely be inadequate considering the risks. It's less than ideal when returns are dependent on the willingness of other market participants to pay an extreme price. An investor in a pricey bond has to hope someone else will be around to buy it when an attractive alternative investment opportunity comes along.***
Otherwise, it is either take a capital loss or, "best case", forgo the opportunity and collect that inadequate coupon until maturity as purchasing power is eroded year after year by inflation..
In a recent Morningstar interview, John Bogle talks about the trend toward speculation and gambling over investing. In the interview, he point to the late 1990s...
"...where the price of the stock became more important than the intrinsic value of a company. And when you focus on prices and pretty much disregard intrinsic values, you are just gambling."
In contrast, when an investor pays a fair price to own part of a business long-term, they're interested in what the asset can produce over time (the underlying economics that determine intrinsic value), not whether price action happens to go the right way. Since the intrinsic value grows faster than inflation, purchasing power isn't just maintained, it increases.
John Bogle later added just how much this trend has crowded out investing:
"...if you call investment fulfilling the basic function of the financial system, and that is directing capital to its highest and best uses, you're talking about money [that] gets directed in new ventures, existing companies, innovative companies, whatever it might be. And that has been running about $250 billion a year. How do you measure speculation? [You do so] by the amount of trading that goes on in the market, and that's around $33 trillion a year."
The simple math means that 99.2% of what's happening in the market is speculation and .8% is an investment. Consider that the next time someone argues the market needs sufficient liquidity. Speculation is just fine and even desirable but, as with any system, proportion matters. We've got plenty of liquidity. What we need is more actual investing.
Investing to achieve favorable long-term outcomes is rarely easy and naturally has its fair share of risks. Yet, that it is inherently challenging shouldn't lead an investor logically to either speculate on near term price action or hide in Treasury securities.
For those with a long-term horizon, many far more attractive investing alternatives exist.
Adam
* See Berkshire's owner's manual for a useful explanation of intrinsic value.
** 10-year Treasury notes are at 1.67% as I write this. So they currently sell for nearly 60 times the interest paid annually.
*** The same is obviously true with a pricey stock but here the option to just hold to maturity in order to get your principal back doesn't exist.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Monday, November 5, 2012
Berkshire Hathaway's 3rd Quarter 2012 Results
Berkshire Hathaway (BRKa) released its latest quarterly earnings this past Friday. Some things worth noting:
1) Berkshire's cash position continues to grow.
The pile of cash on Berkshire's balance sheet is now almost $ 48 billion compared to a bit over $ 40 billion at the end of the prior quarter. So they are still set up for another very substantial acquisition, but Buffett recently said, in this CNBC interview, it's not easy to get deals done due to pricing the current environment.
2) Book value at the end of the 3rd quarter rose 11.9% compared to year-end 2011. At the quarter's end, book value sat at roughly $ 111,700 per Class A share. As I write this, Class A shares are selling for $ 129,800 or a 16% premium over that book value (or 116% of book value). Berkshire announced last year that the company will repurchase shares at a 10% or less premium over the book value:*
Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.
Buffett explained this further in the 2011 Berkshire Hathaway shareholder letter. At that small premium...
...repurchases clearly increase Berkshire's per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower.
It's well worth reading the Intrinsic Business Value and Share Repurchases sections of the latest letter to more fully appreciate Warren Buffett's and Charlie Munger's thinking on this. Also, check out pages 99-100 of the 2011 annual report and the owner's manual for good explanations of how they view intrinsic value. At a minimum, as the share price approaches that 10% premium over the book value, Buffett has made it easy to know when he thinks the shares are selling at an attractive discount to intrinsic value.
The bottom line is that, at the stated price limit, they don't consider the discount to intrinsic value to be small one. In fact, they'd be unlikely to bother buying back the shares if it was.
3) Berkshire was a net seller of stocks during the quarter.
The Consolidated Statement of Cash Flows in the latest 10-Q (the cash flows from investing activities section) reveals, once again, more selling of equity securities than buying. That shouldn't be terribly surprising but is, at least, mildly interesting. More specifically, Berkshire bought nearly $ 1.2 billion in equities while selling nearly $ 3.2 billion worth in the latest quarter.
Quarter-to-quarter changes don't mean a whole lot but the moves are still worth keeping an eye on.
Stepping back just a bit from the most recent quarter, Berkshire bought $ 6.5 billion of equities in the first three quarters of 2012 while selling $ 7.0 billion. That's not exactly running away from equities but, for a comparison, in the first three quarters of 2011 there was over $ 11 billion of equity purchases compared to under $ 1 billion of stocks sold. In any case, we'll get more details on changes to the portfolio when the 13F-HR is released later this month. The specific changes (buying and selling) that occurred should become less of a mystery at that time.
4) Berkshire sold at least some of one or more of its consumer stocks.
Based upon the latest 10-Q, the cost basis of the consumer products (Note 5 under Notes to Consolidated Financial Statements) stocks dropped (from $ 9,843 billion to $ 8,160 billion = a drop of $ 1,683 billion) compared to the prior quarter. So that's where at least a good portion of the selling appears to have been done.
In the prior quarter, meaningful amounts of Johnson & Johnson (JNJ), Kraft (formerly KFT, now MDLZ) and KRFT after the spin-off), and Procter & Gamble (PG) were sold. With the further reduction in cost basis of consumer products stocks this quarter, it seems not at all unlikely that the selling might have continued with at least some of these same stocks.
With the limited information available, it's obviously difficult at best to guess why a stock (or stocks) may have been sold.
Some of the reasons that come to mind include:
Adam
Related posts:
Berkshire Hathaway's 2nd Quarter 2012 Earnings: August 2012
Berkshire's Book Value & Intrinsic Value: May 2012
Buffett: Intrinsic Value vs Book Value - Part II: May 2012
Buffett: Intrinsic Value vs Book Value: April 2012
Berkshire Hathaway Authorizes Share Repurchase: Sept 2011
Should Berkshire Hathaway Repurchase Its Own Stock?: Sept 2011
* 10% premium over the book value or 110% of the book value. It's been described both ways in different publications.
---
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.
1) Berkshire's cash position continues to grow.
The pile of cash on Berkshire's balance sheet is now almost $ 48 billion compared to a bit over $ 40 billion at the end of the prior quarter. So they are still set up for another very substantial acquisition, but Buffett recently said, in this CNBC interview, it's not easy to get deals done due to pricing the current environment.
2) Book value at the end of the 3rd quarter rose 11.9% compared to year-end 2011. At the quarter's end, book value sat at roughly $ 111,700 per Class A share. As I write this, Class A shares are selling for $ 129,800 or a 16% premium over that book value (or 116% of book value). Berkshire announced last year that the company will repurchase shares at a 10% or less premium over the book value:*
Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.
Buffett explained this further in the 2011 Berkshire Hathaway shareholder letter. At that small premium...
...repurchases clearly increase Berkshire's per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower.
It's well worth reading the Intrinsic Business Value and Share Repurchases sections of the latest letter to more fully appreciate Warren Buffett's and Charlie Munger's thinking on this. Also, check out pages 99-100 of the 2011 annual report and the owner's manual for good explanations of how they view intrinsic value. At a minimum, as the share price approaches that 10% premium over the book value, Buffett has made it easy to know when he thinks the shares are selling at an attractive discount to intrinsic value.
The bottom line is that, at the stated price limit, they don't consider the discount to intrinsic value to be small one. In fact, they'd be unlikely to bother buying back the shares if it was.
3) Berkshire was a net seller of stocks during the quarter.
The Consolidated Statement of Cash Flows in the latest 10-Q (the cash flows from investing activities section) reveals, once again, more selling of equity securities than buying. That shouldn't be terribly surprising but is, at least, mildly interesting. More specifically, Berkshire bought nearly $ 1.2 billion in equities while selling nearly $ 3.2 billion worth in the latest quarter.
Quarter-to-quarter changes don't mean a whole lot but the moves are still worth keeping an eye on.
Stepping back just a bit from the most recent quarter, Berkshire bought $ 6.5 billion of equities in the first three quarters of 2012 while selling $ 7.0 billion. That's not exactly running away from equities but, for a comparison, in the first three quarters of 2011 there was over $ 11 billion of equity purchases compared to under $ 1 billion of stocks sold. In any case, we'll get more details on changes to the portfolio when the 13F-HR is released later this month. The specific changes (buying and selling) that occurred should become less of a mystery at that time.
4) Berkshire sold at least some of one or more of its consumer stocks.
Based upon the latest 10-Q, the cost basis of the consumer products (Note 5 under Notes to Consolidated Financial Statements) stocks dropped (from $ 9,843 billion to $ 8,160 billion = a drop of $ 1,683 billion) compared to the prior quarter. So that's where at least a good portion of the selling appears to have been done.
In the prior quarter, meaningful amounts of Johnson & Johnson (JNJ), Kraft (formerly KFT, now MDLZ) and KRFT after the spin-off), and Procter & Gamble (PG) were sold. With the further reduction in cost basis of consumer products stocks this quarter, it seems not at all unlikely that the selling might have continued with at least some of these same stocks.
With the limited information available, it's obviously difficult at best to guess why a stock (or stocks) may have been sold.
Some of the reasons that come to mind include:
- A less than optimistic (or downright pessimistic) view of the long-term prospects for a particular equity
- An expensive share price relative to per-share intrinsic value
- A relatively attractive alternative investment that requires some freed up cash
Adam
Related posts:
Berkshire Hathaway's 2nd Quarter 2012 Earnings: August 2012
Berkshire's Book Value & Intrinsic Value: May 2012
Buffett: Intrinsic Value vs Book Value - Part II: May 2012
Buffett: Intrinsic Value vs Book Value: April 2012
Berkshire Hathaway Authorizes Share Repurchase: Sept 2011
Should Berkshire Hathaway Repurchase Its Own Stock?: Sept 2011
* 10% premium over the book value or 110% of the book value. It's been described both ways in different publications.
---
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, November 1, 2012
Nifty Fifty
The Nifty Fifty were considered the premier growth stocks back in the early 1970s.
"The Nifty Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts claimed that the only direction they could go was up. Since they had made so many rich, few if any investors could fault a money manager for buying them.
At the time, many investors did not seem to find 50, 80 or even 100 times earnings at all an unreasonable price to pay for the world's preeminent growth companies." - Professor Jeremy Siegel in an October 1998 AAII Journal article
Basically, As a group these fifty stocks sold for an average P/E of 41.9 in December of 1972. At the time, the S&P 500 had a P/E of 18.9.*
Professor Siegel compared the returns of these stocks from the market peak in December 1972 through August of 1998.
In some ways, the thinking an investor could pay such high multiples seems not completely flawed. Well, at least at first glance. Over that slightly less than 26 year period, the total return of these fifty stocks (bought at the peak), as a group, ended up being 12.2 percent while the S&P 500 returned 12.7 percent.
So some might conclude that the higher multiples proved to be at least somewhat justified.
There are, I think, some real problems with this point of view.
Even though it worked out okay in the long run, an investor who paid those high multiples had little margin of safety to protect against unforeseen outcomes. It's one thing to look at results after the outcome is certain. It's another thing altogether to pay such a high price going into an unpredictable future. Minimizing the possibility of permanent capital loss is all-important. Practically speaking, an investor needs a sufficient margin of safety when they buy shares of even the best enterprises. Some still argue that an investor should pay up for growth and occasionally it turns out to even work. Yet, if anything, it's probably better to pay a slightly higher (but still a discount to intrinsic value...just maybe a somewhat smaller discount) multiple for those businesses with the clearest durable competitive advantages even if more modest growth prospects.
Durable and attractive core business economics matters more than growth.
Some of the poorest performers in the Nifty Fifty probably appeared to have (and even did...for a while) attractive growth prospects at the time.
(Not surprisingly, among the bottom twenty were some of the leading tech stocks of that time.)
So, even though the returns for all fifty stocks combined did not turn out to be a disaster in the longer run, consider that:
- Paying such high prices meant an investor back then was in a weaker position to deploy as much capital at the attractive valuations that would later come about.
- Only 15 of the 50 did better than just owning the S&P 500. An investor would have done okay buying all fifty stocks. Yet, if not buying all fifty, what's the chance that an investor (in order to get a good result) would pick at least enough of the high performers and not buy the many underperformers? I'm guessing not all that great.
- The total returns may look okay now, but imagine how underwhelming the returns were for most of these stocks during the initial years after they were purchased. Their per-share intrinsic value needed lots of time to "catch up" to the market price (or maybe a combination of increasing intrinsic value eventually becoming more aligned with a decreasing market price). Probably not unlike what happened with certain overvalued high quality stocks back in the late 1990s. Many stocks from the late 1990s needed a decade or more to bring their value more in line with market prices. As I've said before it certainly wasn't just tech stocks that were overvalued in the late 1990s (actually even earlier than that).
- In 1998, the P/Es of these stocks (and, at that time, the S&P 500 overall) were also quite high even if the market would not hit its peak until the year 2000. So Professor Siegel chose two historically rather pricey points in time.
The top twenty performers in the Nifty Fifty (each started with and had to overcome quite high P/Es) from the market peak in 1972 were dominated by the likes of Philip Morris (now Altria: MO), Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), McDonald's (MCD), Johnson & Johnson (JNJ), and Anheuser-Busch (BUD). In fact, out of the top 20 performers, fully 18 of them were either small-ticket consumer (11) or healthcare (7) businesses.**
Unfortunately, the window that opened (as a result of the financial crisis) to buy shares of higher quality businesses at very attractive valuations has mostly closed. No matter how good a business might be, what's sensible to buy at a plain discount makes a lot less sense at some materially higher valuation.
More on this in a follow up.
Adam
Long MO, KO, PEP, PG, and JNJ
Related posts:
The Cost of Complexity - Aug 2012
The Quality Enterprise, Part II - Aug 2012
The Quality Enterprise - Aug 2012
Consumer Staples: Long-term Performance, Part II - Dec 2011
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Forbes magazine added this about the Nifty Fifty: "What held the Nifty Fifty up? The same thing that held up tulip-bulb prices in long-ago Holland—popular delusions and the madness of crowds. The delusion was that these companies were so good it didn't matter what you paid for them; their inexorable growth would bail you out.
Obviously the problem was not with the companies but with the temporary insanity of institutional money managers—proving again that stupidity well-packaged can sound like wisdom. It was so easy to forget that probably no sizable company could possibly be worth over 50 times normal earnings."
** There have many corporate changes to the Nifty Fifty over the years. So some of these companies are no longer separately traded marketable stocks. They have generally either been acquired by other public companies or are now private. The article summarizes the corporate changes that had occurred up to that point in time. Incidentally, General Electric (GE) and First National City were the two others in the top twenty.
---
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 Nifty Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts claimed that the only direction they could go was up. Since they had made so many rich, few if any investors could fault a money manager for buying them.
At the time, many investors did not seem to find 50, 80 or even 100 times earnings at all an unreasonable price to pay for the world's preeminent growth companies." - Professor Jeremy Siegel in an October 1998 AAII Journal article
Basically, As a group these fifty stocks sold for an average P/E of 41.9 in December of 1972. At the time, the S&P 500 had a P/E of 18.9.*
Professor Siegel compared the returns of these stocks from the market peak in December 1972 through August of 1998.
In some ways, the thinking an investor could pay such high multiples seems not completely flawed. Well, at least at first glance. Over that slightly less than 26 year period, the total return of these fifty stocks (bought at the peak), as a group, ended up being 12.2 percent while the S&P 500 returned 12.7 percent.
So some might conclude that the higher multiples proved to be at least somewhat justified.
There are, I think, some real problems with this point of view.
Even though it worked out okay in the long run, an investor who paid those high multiples had little margin of safety to protect against unforeseen outcomes. It's one thing to look at results after the outcome is certain. It's another thing altogether to pay such a high price going into an unpredictable future. Minimizing the possibility of permanent capital loss is all-important. Practically speaking, an investor needs a sufficient margin of safety when they buy shares of even the best enterprises. Some still argue that an investor should pay up for growth and occasionally it turns out to even work. Yet, if anything, it's probably better to pay a slightly higher (but still a discount to intrinsic value...just maybe a somewhat smaller discount) multiple for those businesses with the clearest durable competitive advantages even if more modest growth prospects.
Durable and attractive core business economics matters more than growth.
Some of the poorest performers in the Nifty Fifty probably appeared to have (and even did...for a while) attractive growth prospects at the time.
(Not surprisingly, among the bottom twenty were some of the leading tech stocks of that time.)
So, even though the returns for all fifty stocks combined did not turn out to be a disaster in the longer run, consider that:
- Paying such high prices meant an investor back then was in a weaker position to deploy as much capital at the attractive valuations that would later come about.
- Only 15 of the 50 did better than just owning the S&P 500. An investor would have done okay buying all fifty stocks. Yet, if not buying all fifty, what's the chance that an investor (in order to get a good result) would pick at least enough of the high performers and not buy the many underperformers? I'm guessing not all that great.
- The total returns may look okay now, but imagine how underwhelming the returns were for most of these stocks during the initial years after they were purchased. Their per-share intrinsic value needed lots of time to "catch up" to the market price (or maybe a combination of increasing intrinsic value eventually becoming more aligned with a decreasing market price). Probably not unlike what happened with certain overvalued high quality stocks back in the late 1990s. Many stocks from the late 1990s needed a decade or more to bring their value more in line with market prices. As I've said before it certainly wasn't just tech stocks that were overvalued in the late 1990s (actually even earlier than that).
- In 1998, the P/Es of these stocks (and, at that time, the S&P 500 overall) were also quite high even if the market would not hit its peak until the year 2000. So Professor Siegel chose two historically rather pricey points in time.
The top twenty performers in the Nifty Fifty (each started with and had to overcome quite high P/Es) from the market peak in 1972 were dominated by the likes of Philip Morris (now Altria: MO), Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), McDonald's (MCD), Johnson & Johnson (JNJ), and Anheuser-Busch (BUD). In fact, out of the top 20 performers, fully 18 of them were either small-ticket consumer (11) or healthcare (7) businesses.**
Unfortunately, the window that opened (as a result of the financial crisis) to buy shares of higher quality businesses at very attractive valuations has mostly closed. No matter how good a business might be, what's sensible to buy at a plain discount makes a lot less sense at some materially higher valuation.
More on this in a follow up.
Adam
Long MO, KO, PEP, PG, and JNJ
Related posts:
The Cost of Complexity - Aug 2012
The Quality Enterprise, Part II - Aug 2012
The Quality Enterprise - Aug 2012
Consumer Staples: Long-term Performance, Part II - Dec 2011
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Forbes magazine added this about the Nifty Fifty: "What held the Nifty Fifty up? The same thing that held up tulip-bulb prices in long-ago Holland—popular delusions and the madness of crowds. The delusion was that these companies were so good it didn't matter what you paid for them; their inexorable growth would bail you out.
Obviously the problem was not with the companies but with the temporary insanity of institutional money managers—proving again that stupidity well-packaged can sound like wisdom. It was so easy to forget that probably no sizable company could possibly be worth over 50 times normal earnings."
** There have many corporate changes to the Nifty Fifty over the years. So some of these companies are no longer separately traded marketable stocks. They have generally either been acquired by other public companies or are now private. The article summarizes the corporate changes that had occurred up to that point in time. Incidentally, General Electric (GE) and First National City were the two others in the top twenty.
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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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