Lessons From the Great Minds of Investing

The great mind of investing
This is another exceptional Google Talks. This time Google hosts William Green, the author of The Lessons From the Great Minds of Investing. I met William Green last year following an investment panel at one of the Berkshire Hathaway events associated with the AGM. He had stacks of books that you could buy before it was released to the public. I had a chance to browse the book and its absolutely beautiful. It’s a big book, coffee table style. The striking feature are the beautiful black and white pictures. The extraordinary photographs credits goes to Michael O’Brien. The book provides insights and wisdom from 33 of the greatest investors of our time. Unfortunately I didn’t end up buying the book. The book is too big to travel on a plane with and it’s expensive. But it’s on the buying list and it would definitely make a great gift.

Back to the talk. This is a good talk. William shares a mix of stories and lessons he learned from spending time with some of these great investors. He’s a good storyteller. That’s what makes the talk entertaining. He has some good stories on John Templeton, Howard Marks, Bill Miller and the late Irving Kahn. If you have an hour to kill or to educate yourself, it’s time well spent.

Twitter: @williamgreen72

None other than Buffett. The Great Minds of Investing
None other than Buffett. The Great Minds of Investing

Negative Interest Rates for Dummies

If you ever borrowed money, you are most likely familiar with the concept of positive interest rates. That’s the world where you pay interest on the money you borrowed. Lately, you probably been hearing more and more about negative interest rates, where depositors are actually charged to keep their money in an account and borrowers are paid interest on their debt. I admit that the concept of negative interest rates can take a while to sink in. Imagine a bank that pays negative interest.  The common reaction is “Wait, what! Instead of paying interests on my mortgage I’m receiving interests? Why would a bank do that? I don’t follow you…” or the other popular reaction is “If the bank charge me interest on my deposits I’m taking my money out”. Well it hasn’t gone that far, yet.

Negative interest rates are a last ditch effort by a central bank to stimulate the economy by effectively imposing a tax on the excess reserves that banks hold at the central bank. Banks earn interest on the money, called reserves, they park at the central banks, just like savers park money in a bank. In countries where there’s negative interest rate, the banks have so far mostly taken on the cost on holding excess reserves at the central bank.  At the moment, they haven’t pass the cost on to the consumer, out of fear that doing so might spark a bank run. In some cases, in the Denmark, where some homeowners are getting paid interest on their mortgage. In Switzerland, there’s a bank that’s charging clients to hold their deposits. There’s definitely side effects, both positives and negatives.

Why is this happening? The economy is weak and needs a boost. Banks are a pillar of the economy and are not lending as much as they should. Maybe the standards to borrow are too high following the financial crisis. Maybe there is not enough demand. Whatever the case is, banks are keeping excess reserves at the central bank and are receiving interest on them. Theoretically, low interest rate is suppose to stimulate demand for loans and as a result grow the economy. Central banks provide an ample supply of cheap money to banks in order to encourage lending to various individuals and businesses. But that’s not happening. The banks are “hoarding” the money. You are not growing the economy if you have money parked doing nothing. So to stimulate lending and to get these excess reserve out in the real economy, central banks are charging banks for their holdings.

Denmark set negative interest rates as early as 2012, followed by the European Central Bank in 2014. Since then, they’ve been joined by Switzerland, Sweden, Japan, and Hungary. For some, it’s a bid to reinvigorate an economy with other options exhausted. Others want to push foreigners to move their money somewhere else so they can keep their currency down in an attempt to make their exporters competitive. With the European Central Bank trying to “tank” their currency, Sweden and Switzerland responded. Policy makers are also trying to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery. By weakening their currency, they hope to import inflation by making goods coming into the country more expensive, raising domestic prices.

There are other consequences as well. Retirees are feeling the pain as they need income to live on. The days where you could get a guaranteed 5% on your money have been behind for a few years now, but this is something else. Pension plans, insurance companies, retirees, are being driven in riskier asset classes to make up for the loss income. This works in the short-run as long asset prices are increasing, but is not necessary a sound investment policy. In the long-run, who knows what the consequences are? It’s uncharted waters. There are other side effects, Sweden is dealing is a potential housing bubble and people are on a borrowing frenzy. It might ended up badly once rate rises. The best analogy I heard about the dilemma is the joyful feeling of eating McDonald’s right now. It’s delicious in the moment but the perverse effect of eating it will show up later.

Both Canada and the U.S. have their current interest rate at 0.50%. After decreasing them last year Canada just announced they were maintaining their rate. The U.S. are slowly starting to increase them after almost ten years of no increase. There is debate on whether they should go negative. Rates are just above zero, so nobody knows if going negative will actually make a difference. So far the North American central banks are looking at the experience in other countries and will judge the results.

Negative interest rates are a sign of desperation, a signal that traditional policy options have proved ineffective and new limits need to be explored. They punish banks that hoard cash instead of extending loans to businesses or to weaker lenders. It’s a bid to boost the economy. Is it working? So far the experiment doesn’t prove to be fruitful. Instead of boosting lending like the theory states, banks are taking on the cost which hurt their income, and as a result tighten credit. If banks are not profitable, they don’t lend.  Another perverse effect, banks have been unwilling to pass on negative rates to individual depositors, and have tried to compensate for profits by jacking up mortgage rates, even as headline interest rates fall. These are not the results they were hoping for. Taking such action is suppose to help the economy, not hurt it.

This is where a herd of academics, bankers, analysts and economists are getting in a never ending debate, and the person with the argument that nobody understands usually wins. You get the feeling that nobody knows what they are doing. Falling prices, banks paying you money, it’s a confusing world. I hope this clarifies the insane world of negative interest rate.

Berkshire Hathaway 2016 AGM

*Updated April 20th.

I will be in Omaha for the 2016 BRK AGM. I will be there from Friday April 29th to Sunday May 1st. I’m planning to leave not to long after the Markel Corp. meeting. If anybody wants to meet up, I will be at some of these events:

Friday, April 29:

  • Noon-3pm: Berkshire Exhibition Hall visiting companies.
  • 3pm: Value Investing Panel at Creighton University
  • 5pm: Yellow BRKers get together
  • Columbia University “From Graham to Buffett & Beyond” dinner????
  • 8pm: Whitney Tilson’s cocktail party

Saturday, April 30:

  • 8am-4pm BRK AGM. I’m watching a 85 and 92 year old take questions for hours.
  • 4pm – YPO has an event with Tom Gayner (Markel), Tom Russo from Gardner Russo & Gardner, and and Tim Vick, author of How to Pick Stocks Like Warren Buffett. Not sure if I will go because I’m not a YPO member.
  • Another event by Whitney Tilson and his friend Chuck Gillman. Whitney won’t be there. It’s a casual get-together immediately following the annual meeting.
  • 5:30pm: I might attend the Nebraska Furniture Mart Cookout. It was a lot of fun last despite the long line to get in. Music, BBQ and Budweisers. BTW  Nebraska Furniture Mart which is the largest furniture shop in the US.
  • There are various investment events Saturday night, not sure where I will end up.

Sunday May 1

  • So far I’m not register for the BRK 5km race. I did it last year. I may or may not go.
  • 10am: Markel Corp. brunch. I really enjoyed it last year. Smaller and more personal than the BRK meeting.

There are various events associated with the BRK AGM, so the schedule is subject to change.

Chasing Hot Stocks Is Expensive

I enjoy reading CEO Prem Watsa’s annual letters, with the latest one here: 2015 Fairfax Financial Holdings Annual Letter. He’s been labelled the “Canadian Buffett”. Like Buffett, Watsa also runs an insurance conglomerates that preach value investing.

I have clipped two tables below that are particularly interesting. The first table demonstrates what happened when you chase hot stocks and the 2nd one is the latest valuation of the “unicorns”. In the first table, the only one in the group that might not belong there is Netflix, since its returns over a five-year (chart) period is monstrous. On the other hand, Netflix never looked cheap and people investing in it in the last two years were pretty much jumping on the bandwagon that they missed, hoping to score a quick financial gain. A lot of the stocks below, like Twitter and Groupon, are trading below their IPO price.

If you tune in to your favorite popular financial 24hr media channel, it would seem that there only ten companies in the world to talk about. However, the best opportunities are where nobody is looking.

Bubble stocks
Fairfax 2015 Annual Report, page 22.

The 2nd table shows the latest valuation funding from the so call “unicorns”.  A unicorn is a private startup company valued at $1 billion dollar or more. They are interesting and very disruptive in some cases like Uber and Airbnb. But it’s also important to make money. Since these companies are private, there’s no way of knowing if they are profitable. An educated guess tells me that most of these companies are bleeding cash. That’s why they constantly need more funding. And the next round of funding is always at a higher valuation. You can play that game as long the capital markets/private investors like you. But, what we are witnessing according to the table and news, valuation in the private startup world is falling apart. There a new label going around: unicorpse.  That means the bubble is bursting. Many of them cannot fund their losses internally for more than a few months and now have almost no access to external funding. Layoffs have begun in many of these companies. Money is being raised at lower valuations than the previous round of financing and the cycle is now in reverse. Uber is worth $62.5 billion?!?!

Fairfax Financial 2015 Annual Report, page 22
Fairfax Financial 2015 Annual Report, page 22

If Donald Trump Published an Academic Article

There are a lot of Trump jokes out there and this one has actual brain and work put into it. It’s worth sharing. This joke is named “If Donald Trump Published an Academic Article”:Trump Academic Paper

 

Dream Big

Dream BigDream Big by Cristiane Correa is a quick easy 200-something pages book to read. If you want to know more about the Brazilian trio behind 3G Capital that bought American icons Budweiser, Burger King, and Heinz, this is your book. The mostly focus on beginning and rise of Jorge Paulo Lemann, Marcel Telles and Beto Sicupira. Jim Collins, the author of Good to Great, provides the foreword.

Dream Big is the story of three Brazilians that’s taking over the world. This is not a how-to guide. You are not going to be a management guru after reading this book. You will learn some stuff but you will have to look else where for a practical program and advice. Sure, you will read a little bit about zero-based budgeting but it’s not going to tell you how implement it. There are other books for that.  Nevertheless, it’s a fascinating story.

In Brazil, Jorge Paulo Lemann, Marcel Telles and Beto Sicupira were well known for their success with Garantia, a Brazilian investment bank. Outside Brazil, notably in America, they were practically unheard of until they put their hands on Anheuser-Busch with its trademark brand Budweiser. Then they bought Burger King and Heinz not too long after. Three giant America icons now in the hands of some Brazilians investors. You can also add Kraft and Tim Hortons to the list. They took the corporate and financial world by storm. As you can imagine, a lot of questions were raised. How did this happened? Who are these guys? What’s going on? Who are they invading next? Why is Warren Buffett partnering up with these guys? The true is that these guys have been working at their craft for a really long time before they started swallowing American giants. The book walks you through the purchase of Anheuser-Busch.

What’s the secret to their success? There’s no secret or magic formula. Their method is  a simple, straightforward business approach. They didn’t reinvent the wheel. They took the best management concepts and applied them. They preach one thing: Meritocracy. It’s all about performance. Status, credentials, age is irrelevant. Look for good people, train them, keep them, and reward the best. They have this 20-70-10 rule they got from Jack Welch’s GE. Make it rain on the top 20% of your employees. These are your money makers. Considerable rewards, in cash, equity, promotion, are available to those who hit tough targets at company, unit and individual level. The other 70% are good employees, so you maintain them. The bottom 10% are fired. This is similar to the 80-20 rule, where 20% of your employees are responsible for 80% of your results.

“Costs are like fingernails. You have to cut them constantly” – Beto Sicupira

One way to look at the future of recently acquired Kraft, is to see how the previous deals played out. You can’t bring up 3G Capital and not talk about job cutting. The first thing that pops into people’s mind if you mention 3G, it’s job losses. 3G doesn’t have a great reputation and I think they don’t care.

The reality is these guys wants to create long-term value. Yes they cut cost, but they also invest where it’s going to be productive. It’s the 2nd part that the media ignore. But it’s also not sexy and not as dramatic as closing a plant. 3G is not the slash-and-burn type. They keep their businesses for really long time. The true harsh reality is that you are not making society better by wasting money and not being efficient. A company that has too many employees and is bloated is not contributing as much as it should to society. 3G streamlines away a company’s inefficiencies and improves it. For example, when they bought Anheuser-Busch, one of the first thing that got eliminated was the board’s fleet of private jets called “Air Bud”. Executive are now flying coach. 5-star hotels also got the scrap. Now its 3-star hotels, sometime having to share a room.  Once they are done they buy another company. We live in this wonderful high-tech world with never ending improving living standard because of focus on productivity and innovation. A small trip to the good old Soviet Union or Cuba will give you a glimpse at the opposite, and everyone has a job.

3G’s companies is popularizing zero-based budgeting, a system where, instead of basing budgets on the previous year’s, managers started at zero every 12 months and had to make a case for why they should get more. These guys are deadly efficient with their money. Managers are handed out this book: How to Double Your Profits in 6 Months or Less (brutal title). The books states that there’s 78 proven ways to cut costs dramatically. I haven’t read the book so I don’t know but it seems to work for 3G.

3G Capital’s method and culture is definitely not everyone’s cup of tea and they know it. There’s short-term social cost to their method but in the long-run I believe the benefits outweighs the cost. It remains to be seen what will be their next giant target.

Apple Computer’s IPO

Apple Computer's first logo. 1977
Apple Computer’s first logo. 1977

One of my most popular article to date on Seeking Alpha. It’s was a top trending article for two day and it has received a lot of good comments. I’m proud of the achievement but again any article on Apple, Facebook, Google, or the cool stock of the moment will get you trending. It’s great, but it also goes against what Seeking Alpha is about, which is shining a light on companies with limited or no coverage. SA still serves that purpose and it’s great for that, but it’s still hard to get attention sometimes on little unknown companies. Apple has so many analysts so I’m not sure why people bother writing articles about it on SA. There are so many companies that are bargains but nobody has never heard of them.

Anyway here’s a preview of my article on Apple’s IPO. The full article is free on SA. I suggest you go read the comments. There’s a lot of good stuff there. It’s almost like a trip down memory lane for so many people.

Enjoy!


 

Apple Computer’s IPO

Summary

  • Apple was a 205-bagger from 1990 to today (3-17-2016), without calculating dividends.
  • But you needed an 80% loss twice in order to get it.
  • Not your classic buy and hold fairy tale.

I’m a big fan of history and business. Combine both of them and you have quite a passion. While reading on what makes companies into multi-baggers, Apple Inc. (NASDAQ:AAPL) came up. I started researching old documents on Apple Inc. which eventually led to the IPO. I wanted to know, what at the time, made Apple a multi-bagger. Multi-bagger is a term popularized by Peter Lynch, author of One Up on Wall-Street and a manager at the Magellan Fundat Fidelity Investments from 1977 to 1990. Peter Lynch often uses the term “10-bagger,” which is when a stock goes up 10 times in value. I hope I’m not shocking anyone by stating the fact that Apple qualifies as a multi-bagger. Actually Apple is a multi, multi-bagger. My research led me to the Apple IPO, which was pretty interesting itself. So I decided to make an article out of it to share some of my research and findings. I might write an article on multi-bagger companies later. At today’s price of $105, Apple is a 205-bagger plus from 1990 to today, without dividends. For those who observed Apple’s share price from outside, the stock performance seemed to be an unbeatable machine. However, a closer look would reveal that it wasn’t always a fantastic engine.

In 1977, Apple Computer (now known as Apple, Inc.) was a very different company and Steve Jobs was a very different entrepreneur. Apple had its IPO in 1980 which I review in detail below. By looking at Apple’s stock price today, around ~$105 post-split, investing in Apple at the beginning would have looked like a no-brainer. You always hear people saying that if they bought Company X when it first came out, they would have been multi-millionaires today. The real story for early Apple investors, however, wasn’t all sunshine and rainbows. This is not your classic “buy and hold” fairy tale. If you would have bought Apple at the beginning and held on to it, you would have been clinically depressed for a good part of your life, unless you get joy out of pain. I did open my article by mentioning that Apple is a multi-bagger, but you needed an 80% loss twice in order to get it.

First, let’s start with the IPO then I will walk you through the performance history.

The Successful IPO

*Price per share mentioned are pre-splits numbers unless mentioned otherwise.

Source: Clipping from The New-York Times, December 15, 1980 – By Vartanig G. Vartan – Business – Print Headline: “New Stocks Drawing Intense Investor Interest”

I like how the clipping above had to mention that Apple was a Californian company that makes personal computers. For part of the research, I have to thank the Computer History Museum and The New York Times archives for my research. The Computer History Museum has two special documents from Apple Computer during the early days of personal computing. The first is thePreliminary Confidential Offering Memorandum – a document supporting a private placement of funds for Apple before the IPO. The document also contains the product and marketing plan. Computer History Museum CEO John Hollar noted the plan also “goes to great lengths to explain why anyone would even want a personal computer (e.g., forecasting eight reasons “that indeed, by 1985, a household using a computer will have significant advantages over one that doesn’t”), and that every single competitor listed is no longer in the PC business.” And if you are really interested, the second document is thePreliminary Macintosh Business Plan, which is post-IPO.

Source: Apple’s Preliminary Confidential Offering Memorandum

Apple Computer Inc., now renamed Apple Inc., had its IPO (prospectus) more than thirty-five years ago, on December 12, 1980, with 4.6 million shares priced at $22 ($0.39 a share post-split). Since then the stock has split four times, including three 2-for-1 splits (1987, 2000, 2005) and recently one 7-for-1 split (2014). That means your 100 shares would have multiplied into 5,600 shares today, or 56 times your original holding. Apple raised $101 million. Apple sold 7.4% of the company of the 54.2 million shares outstanding at the time. On that day, the Dow soared 21.59 points to 958.79, staging its biggest one-day rally since spring 1980. The Dow jumped because of a surprise half-point reduction in the prime rate by Wells Fargo to 20.5%! (Yes, you read that correctly, interest rates were extremely high back then, don’t ever forget that it could happen again).

During fiscal year 1980, Apple had sales of $118 million, up from 774k in 1977. Earnings also came at $11.7 million, or EPS of $0.24, compared with $41,575 or EPS of $0.01 in 1977. Now, think of how much Apple makes every minute. In 2015, Apple had sales of $233.7 billion and $53 billion in net income. Apple had a second offering of 2.6 million shares that quickly sold out in May 1981.

I found old news clipping below from The New York Times archives on Apple’s IPO.

Source:The New York Times, December 13, 1980. First Business Page, Part 1.

Source:The New York Times, December 13, 1980. Page 3 of the Business Page, Part 2.

Source: The New-York Times, Business Digest, Saturday, December 13, 1980.

As the article states, the IPO was a major success. The shares jumped immediately to $29, peaked at $29.25, and closed at $28.75. The offering happened to be the largest IPO in 15 years at the time since Comsat (side note: Comsat is the same company that owned the Denver Nuggets from 1989 to 2000, and bought the NHL Quebec Nordiques and moved them to Denver as the Colorado Avalanche. Comsat was acquired by Lockheed Martin Corp. (LMT)). The original offering was estimated at between $14 and $17, but due to strong demand was raised to $20 and $22.

Sorry, to cut you short, the full article is on SA or they will ask me to take it down. Thanks.

Price And Value…

I found this condensed passage below very interesting. I think it should be read in conjunction with my latest article, My Investment Approach.


Reposted from Value Investing World
From Capital Returns:

It should never be forgotten that, in its most basic form, investing is always and everywhere about price and value. Price is what you pay, says the Sage of Omaha, and value is what you get. By this definition, every serious investor must be a value investor. This is not to say that investors should restrict themselves to buying companies with low valuation multiples. The business of investment is ultimately about buying stocks at a discount to intrinsic value.

So how do you calculate value? Well, in theory the value received is derived from future cash flows discounted back to today at the appropriate discount rate. The trouble is that we are rather poor at making predictions, especially about the future. But that doesn’t put us off. We suffer from what Nassim Taleb calls the “epistemic arrogance” – in plain English, we think we are better at making predictions than we really are. The result is that we have a misplaced sense of confidence in our forecasts. Investors like modelling because it appears scientific (the more spreadsheet tabs, the greater the effect).

Investment models, however, encourage anchoring. Most models are calibrated to produce a current value for a company within a reasonable range of the current price. Another wrinkle is the discount rates. If you don’t accept that historical volatility (beta) is a good measure of risk (which we do not), then it’s not clear how to calculate the appropriate discount rate. At Marathon, we believe that detailed forecasting adds little value.

One common response to the difficulty of forecasting is to turn to simple value proxies, such as the price-to-book ratio, price-to-earnings ratio, and free cash flow yield. Many “value” investors advocate buying a basket of stocks which are cheap by these measures. There’s nothing inherently dumb about this approach. Each of the measures is a very useful indicator of potential value, but there’s a danger of oversimplification. Traditional valuation measures say nothing about the specific context of an investment – for instance, a company’s business model, its industry structure, and management’s ability to allocate capital – which determines future cash flows.

Quantitative valuation measures also tend to encourage a narrow categorization of investment styles. Take for example the S&P US Style Indices. Value stocks are defined by their ratios of price-to-book, price-to-earnings, and price-to-sales. The growth index, on the other hand, is defined by the three-year change in earnings per share, three-year sales per share growth rate, and 12-month price momentum. While some of these factors are powerful, they are too crude to be the sole framework for assessing value.

My Investment Approach

A brief overview of my investment process. This is a partial publication and the full article is available free of charge on Seeking Alpha.

  Continue reading “My Investment Approach”

Seth Klarman 1991 Barron’s Interview

Below is a rare 1991 Barron’s interview (pdf) with Seth Klarman from the Baupost Group. He’s also the author of the out of print Margin of Safety, which a copy sells for over $1,000.

Credits to “The Odd Lot” from oddlotinvest.wordpress.com/. For some reason the website is no longer available.

Barron’s 1991 interview with Seth Klarman