Berkshire Hathaway Memo

First, some comments on the pre-AGM webinar hosted by Professor Lawrence Cunningham, then I will comment on Berkshire Hathaway (BRK). Professor Cunningham occasionally does this kind of event and is generous with his time. Here’s the recording.

There were about a thousand of us on Zoom. Professor Cunningham did something similar two weeks ago when for the launch of his new book: Dear Shareholder: The best executive letters from Warren Buffett, Prem Watsa and other great CEOs (see post). Professor Cunningham is a Buffettphile. Lawrence is a professor of law at Georgetown. But he’s better know for his work Buffett and BRK. Lawrence has done a great job representing Buffett’s views. He had access to Warren for over twenty years. He has documented many angles of BRK/Buffett through the years. If you are an investor and you want to get better, then the book you should read The Essays of Warren Buffett: Lessons for Corporate America. A new edition comes out every five years to stay current with Buffett’s views. The book covers a lot of topics. Corporate governance, culture, management, values, investing etc…really it’s a gem. It’s not that big and packs a lot.

Anyway the pre-AGM meeting was good to get into some-kind of BRK groove. I don’t know if you have been to a BRK AGM, but an online AGM doesn’t quite catch the vibe. If you are a value investor, you have to attend at least once in your life. Hopefully we can defeat COVID-19 ASAP and move on to better things.

Berkshire Hathaway Notes

It goes without saying that BRK is a special company. There’s nothing else like it. There are clones, but they are not as successful. Maybe except for Markel Corp. (MKL) which is probably the best clone I can think off. MKL emulates BRK and Buffett in many ways. They have good insurance companies, good management, good businesses, a good culture and a great shareholder letter. Fairfax has solid insurance companies but is lagging behind on the investment side. I don’t know if there’s something equivalent of a BRK in Europe or Asia (there are a lot of giant conglomerates). The BRK recipe has been laid out. You can copy it. But the large majority can’t do it. BRK has such a unique culture which explains why it’s hard to replicate (autonomy, decentralization and trust). Also people don’t have the patience. Everybody wants to be rich but they don’t want to do it slowly.

That Cash Pile

BRK Cash

BRK is sitting on $137 billion and he’s getting heat for it: “He’s not buying anything, he missed the dip, he didn’t do enough buybacks etc…” So who cares about sixty years of investing greatness. Really I don’t get the hate. I saw a video of a guy on Twitter burying a Buffett book. To the people that are giving Buffett crap for having all that cash, just take a quick look at the state the companies that don’t have any cash are in.

I don’t know about you but that pile of cash looks really good right now. We are a quarter into this Covid-19 mess. There’s a lot we still don’t know. We have no clue how this will play out. A second wave? Another shutdown? An Italian style public health crisis? We will get out of this mess eventually, but when and how much it will cost are unknown (astronomic!) A lot of people pretend to know, but nobody knows.

The current market rebound doesn’t reflect the reality I see right now. People are losing their businesses, their jobs, their savings, debt is pilling up…none of this is a quick fix. I understand that the market is forward looking and that most of the valuation is on the back end (terminal value). We will have a better idea of the real damage done in the summer and fall once bankruptcies starts to flood in. Governments are telling restaurants to open at 50% capacity. Do you know how hard it is to make money with a restaurant running a full capacity during good times? What about these stores in the mall? The current market rebound is based on the central banks doing everything there is to do to at any cost.

Buffett also said this about the $137 billion he had on hand: “Isn’t all that huge when you think about worst-case possibilities.” He’s certainly in a better position than anyone to make that judgement call.

The Fed

Back during the Financial Crisis of 2008-09, BRK made some of the sweetest deals. Buffett saved Goldman Sachs, General Electrics, Bank of America, Harley Davidson, Tiffany and I’m sure they are more. He had money, they needed it.

This time there were no deals. The main reason was the the Federal Reserve and government stepped in very aggressively.  They learned from the last crisis. And you can’t compete with their terms.

Buffett Federal Reserve

As a consequence of their buying spree of epic proportion, the Federal Reserve’s balance sheet has exploded to over $6 trillion. Look at that spike at the end of the graph. That’s one swollen balance sheet.

Federal Reserve Balance Sheet
Federal Reserve Balance Sheet as of April 29, 2020

Bearish

Buy American
Six months before the bottom in March

Buffett is known for his eternal optimist. People turn to Buffett for some-kind of hope. Back in 2009 he wrote an op-ed in The New York Times saying he is buying American stocks! Then the market went down for another six months. But his message and action remained iconic. Having the right temperament and attitude can help you navigate hard times.

Last Saturday listeners where waiting for this kind of up-beat mood lifter and let’s just say they got buzz killer. He came across as quite bearish (more realistic IMO) during the virtual meeting and that’s scary. Investors turn to Buffett for guidance during hard time.  Stocks are apparently low (kind of not really) and he’s not buying. It’s probably not the message investors wanted to hear. But sometime you need to hear the truth. And right now the truth is not going to be pretty for a while. Remember he’s an Oracle…

You have to understand that through BRK, Buffett has a direct pulse on the business world, from small to big businesses from many different industries. He knows what is going on.

Also when Bill Gates is your best friend, and Bill seems to knows everything there is to know about pandemics and Covid, you are probably getting better facts than the White House briefings.

“I Don’t Know”

Buffett said “I don’t know” a lot during the meeting. Smart people says I don’t know a lot.

I think we don’t say it enough. Buffett understands his circle of competence. If it’s out of his league, than you get a “I don’t know”. It’s important to be intellectually honest. That way we can grow and make less mistakes. We should say “I don’t know” more often. It will prevent less b.s. floating around.

Successor

Nice to see Greg Abel up there. We got an extensive look at a man who could succeed Warren Buffett. He looked good. He demonstrated very broad knowledge across the company. Abel is a vice chairman for non-insurance operations. Abel gave investors a sense of how those operations were adjusting to the coronavirus pandemic and economic landscape. The other candidate for succession, Ajit Jain, is the vice chairman overseeing the insurers.

Buffett Exits Airlines

How to you become a millionaire? You start off as a billionaire then buy an airline.

Buffett sold all his airlines. Good riddance. “When we change our mind, we don’t take half measures”. To Buffett’s credit, he didn’t nor seek to assign blame elsewhere. He just said he made a mistake.

There’s probably other motives too. Buffett is the 2nd or 3rd richest man in the world and ex biggest investor in the airlines. Just think of the headline: “Billionaire Buffett’s Airlines receive bailout money” or “$137 billion cash pile and Buffett needs government help”. Buffett is careful of his image and he doesn’t need that political/public backlash that would have follow. Billionaires don’t need a bailout.  He made a mistake, recognized it, and move on.

Quiet Buffett

As the coronavirus crisis unfolds, many are asking: Where is Warren Buffett? They want to hear and see more from the famed investor, noted for both calm and prowess in times of distress. Well he did an one interview back in February (CNBC) and another one in March(Yahoo! Finance). His AGM was coming up so most likely save the spot for all the questions. Buffett has already given the world so much. He’s 90 years old. He’s been doing this for sixty plus years. He doesn’t owe us anything more than he’s already said and done.

It’s possible there are other forces at work here. We are in a pandemic and recession. I’m not sure it’s smart to have Buffett hopping around of happiness like a little kid because “the supermarket is on sale” while people are dying or losing their jobs, money, or business.

The End

End

Legacy of Benjamin Graham

The Heilbrunn Center for Graham and Dodd Investing created a video titled ‘Legacy of Ben Graham,’ which contains bytes from some of his students, such as Warren Buffett and Irving Kahn, on how Graham’s teachings changed their lives.

Joel Greenblatt – Great Value Investors Need To Be Cold Hearted JellyBean Counters

Here’s a great video by Joel Greenblatt, author of You Can Be a Stock Market Genius,  with less than 3,000 views. In a segment, he talks about how outside influence, or “group think” affects our judgment, and basically on how we price stocks.

 

Seth Klarman Investment Wisdom

Below are the updated links to Seth Klarman’s investment wisdom. You can find the full archive at the Investment Resources.

You can also buy one of the most famous book ever on investing, Margin of Safety by Seth Klarman, for $7.58 on the Kindle. Hard copies are going for $500 to $1000 each. Of course you don’t get the joy of holding a hard copy of this rare book in your hands, but you get access to its treasured wisdom.

Seth Klarman (Baupost Group)

Disney Podcast

I recently found out that one of my article was the subject of a podcast

I wrote an article on Disney that received a lot of reaction (may or may not be behind a paywall, SA’s policy often changes).  In the article I share my thoughts and insights on the future of Disney. Interestingly, the editor of SA picked up my article for their latest podcast. I didn’t know they did this and I’m not in it. But it’s a good extension to my article.

Thoughts On Value Investing

I frequently hear some members of the value investing community complain that “value investing no longer seems to work”.  In my view, paying less than something is worth will always work. I guess what these investors may mean is that paying low multiples for mature, easy to understand businesses no longer seems to work.

Value investing has for reputation of paying a low multiple for a business and wait for the market to recognize its true value. But if you tried it, it doesn’t seem to always work that way. I have seen companies trading at 5x price-to-earnings (P/E) dropped to 2x P/E. The idea of only trading stocks on a low multiple of earnings is absurd. That would be too easy and it’s not supposed to be easy. If it was the case everybody would be rich doing that.

All businesses are worth the cash that they generate between now and eternity, discounted at the appropriate rate. The path that different companies’ cash generation takes can vary enormously. Some businesses may have outlived their useful purpose and be in liquidation. Others may have reached maturity and the current level of cash flow might be expected to continue indefinitely. Still others may have negative cash flow today as they invest to build growing cash flow in the future. At an appropriate price, each of these companies can be considered value investments. Only the size and the duration of the future cash flow relative to the price can tell you if it’s cheap. “There are no bad assets, just bad prices”.

I’ve own stocks with a P/E ratio that many money managers would label as high. I try to find out the free cash flow per share the company is generating, and I value the business based on that rather than GAAP P/E numbers. You need to ask yourself what are the fundamentals of the business in relation to its price? If you paid 20 times for a business that was compounding the economic value per share in the mid-teens and have some level of confidence it is likely to do that for a reasonable period of time, you should do all right. Here’s a stock tip: when Warren Buffett analyze a stock (which is a partial interest in a real business not a piece of paper) they discount the cash flows, not the P/E ratio.

Graham’s Net-Net Stocks

“Heavy ideology is one of the most extreme distorters of human cognition.” – Charlie Munger

Hardcore disciples of Graham and Dodd wouldn’t probably agree with my post. But have you tried investing in “net-net stocks”; companies trading below its net working capital. Of course I would love buying a company for less than its cash but there’s a reason why these companies are cheap. First, to do that, you really need to know what you are doing and it’s a lot of work. Maybe with a small amount of money you can make it work. However I doubt the risk and potential returns are worth the headache. True net-nets are hard to find and the one that comes off a filter are of dubious quality. Thomas Hobbes described the life of mankind as “nasty, brutish and short.” This is what you get on the list that typically pass the Ben Graham net-net working capital screen. Investors are much more efficient today than during Graham’s era.  Let’s just say there are better alternatives, like buying a high quality company.

You need to keep learning. You need to adapt. You need to evolve. You need to be mentally flexible. Nobody demonstrates this better than Buffett. Buffett evolved from the cigar-butt approach he learned under Graham to being the largest investor in Apply. He’s been at it for over fifty years and his style has evolved many times.

One might think that Buffett buying 140 million shares of Apple would dispel the notion that value investing as an analytical style is about buying “cheap stocks.” Quality is a key part of value and may not be reflected in current price creating a bargain or a margin of safety. The point is some bargains are only visible if you understand qualitative factors. I guess the holy grail of investing is buying a high quality company in high growth market with negative capital need at a discounted price.

Buy and Hold

Many also say that buy-and-hold investing no longer beat the market the way it did in the past. Buy and hold shouldn’t be your philosophy. What I want to do is own businesses that are exceptional until they are no longer exceptional. It’s a nuance on the notion of buy and hold. But it’s easy to call it buy and hold. There’s a saying in the investment world: “let your winners run, and cut your losers.” One of my greatest mistakes was selling my winners way too early. Peter Lynch said that “selling your winners and holding your losers is like cutting the flowers and watering the weeds.”

Technology

Historically value investors eschewed the tech sector because 1) its outside the circle of competence and 2) the tech sector is too fast moving. For long-term investors, basing investment decision on cash generation into the future, the sector was un-investable. Clearly, companies like Google, Apple or Amazon are far two entrenched in our modern, Internet-driven economy to be considered un-investable for the above reason. The change brought about by the Internet, mobile, and soon AI is fundamentally changing the economic basis of nearly every established business (look what Uber did to the taxi industry). A refusal to engage intellectually with these changes not only means that you miss out on the investment opportunity they throw up, but it blinds you to the fundamental changes taking place at every “easy to understand” business. It’s important to expand your circle of competence. In the past P&G or Coca-Cola were easy to understand branded consumer products. Today Apple is the modern-day incarnation of branded consumer goods company.

To conclude, what is within and what is beyond our circle of competence must continue to evolve over time. Risk comes from not knowing what you are doing, so it is wise to stay within your circle of competence. As for value investing, over time you need to keep re-calibrating the definition of value investors. The beauty of some systems is that they have the ability to evolve so as to adapt to new conditions.  Value investing evolves over time and keep an open mind on what constitutes value.

Greenblatt: Opportunity Is There If You Know How to Value Business

Greenblatt discusses active versus passive investing and some of the reasons why he still believes active investing is the better option saying:

“I was asked to give a speech at Google last year and I started it this way… I said even Warren Buffett says that most people are better off just indexing and I said I agree with him… I didn’t stop my lecture there. I said… but then again Warren Buffett doesn’t index and neither do I don’t… how come? It’s because the opportunity is there if you know how to value businesses. Which most people do not… To take advantage of the fact that the market is emotional over the short term… often!

Martin J. Whitman – Value Investor

Martin Whitman, an incredible value investor and teacher, passed away at 93 years old (Business Wire). Below are a short compilation of links on the value investing legend. The shareholder letters are great. I learned a lot from Martin. You can more investment wisdom by other great investors archived here.

“The financial world is so complex and unpredictable that a fair amount of our analyses will prove to have been flawed…. A dirt-cheap price is an anchor to windward against misperceiving current situations, or being unable to make accurate forecasts.”

—Marty Whitman

Li Lu – Himalaya Capital

Here’s the latest addition to my investment collection of useful resources. Li Lu manages Charlie Munger’s money and one of the candidate to manage part of the Berkshire Hathaway’s portfolio. He’s a very interesting investor to follow.

Li Lu (Himalaya Capital)

How to Evaluate Businesses

“So how do you really understand and gain that great insight? Pick one business. Any business. And truly understand it. I tell my interns to work through this exercise – imagine a distant relative passes away and you find out that you have inherited 100% of a business they owned. What are you going to do about it? That is the mentality to take when looking at any business. I strongly encourage you to start and understand one business, inside out. That is better than any training possible. It does not have to be a great business, it could be any business. You need to be able to get a feel for how you would do as a 100% owner. If you can do that, you will have a tremendous leg up against the competition. Most people don’t take that first concept correctly and it is quite sad. People view it as a piece of paper and just trade because it is easy to trade. But if it was a business you inherited, you would not be trading. You would really seek out knowledge on how it should be run, how it works. If you start with that, you will eventually know how much that business is worth.” -Li Lu

Li Lu is the only guy that manages Charlie Munger’s money. And he has an incredible story about his up bringing. Twenty-one years ago, Li Lu was a student leader of the Tiananmen Square protests. Now a hedge-fund manager possibly one of the successor to he is in line to become a successor to Warren Buffett at Berkshire Hathaway.

His book seems rare and hard to find. There’s a copy on Amazon: Moving the Mountain. He’s expensive so it’s probably one of these rare books that you might find by accident somewhere. Li Lu also wrote the foreword to the Chinese version of Poor Charlie’s Almanack.