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
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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.