Wednesday, April 23, 2014

Buffett: Shareholders Should Speak Out on Coca-Cola

Mr. Buffett abstained from voting on the Coca-Cola compensation plan. He said it was excessive, but that he could never vote against Coca-Cola. But the plan, as expected, did pass the shareholder vote.

April 23 (Bloomberg) -- Warren Buffett, the billionaire chairman of Berkshire Hathaway, explains why he abstained from voting on Coca-Cola Co.’s plan to award employees with stock, how he feels about tech stocks and the U.S. housing recovery. He speaks with Betty Liu on Bloomberg Television's "Street Smart."

Ernest Hemingway on Writing

Before I forget, Josh Waitzkin and Tim Ferriss highly recommended the book below in the interview I posted yesterday.

Link to book: Ernest Hemingway on Writing (or the if you prefer the Kindle version, go HERE)

Hayman Global Outlook Pitfalls and Opportunities for 2014 by Kyle Bass

Intro from ValueWalk:
Kyle Bass gave a presentation at the CFA SOCIETY DALLAS-FORT WORTH ANNUAL FORECAST DINNER on February 14th. A copy of the presentation has been obtained by ValueWalk. Below readers can find the full video of Kyle Bass speaking as well as the 20 pages, the theme of which was titled, ‘Hayman Global Outlook Pitfalls and Opportunities for 2014 ‘

LINK TO VIDEO

The Moral Power of Curiosity – by David Brooks

Most of us have at one time or another felt ourselves in the grip of the explanatory drive. You’re confronted by some puzzle, confusion or mystery. Your inability to come up with an answer gnaws at you. You’re up at night, turning the problem over in your mind. Then, suddenly: clarity. The pieces click into place. There’s a jolt of pure satisfaction.

We’re all familiar with this drive, but I wasn’t really conscious of the moral force of this longing until I read Michael Lewis’s book, “Flash Boys.”

As you’re probably aware, this book is about how a small number of Wall Street-types figured out that the stock markets were rigged by high-frequency traders who used complex technologies to give themselves a head start on everybody else. It’s nominally a book about finance, but it’s really a morality tale. The core question Lewis forces us to ask is: Why did some people do the right thing while most of their peers did not?

The answer, I think, is that most people on Wall Street are primarily motivated to make money, but a few people are primarily motivated by an intense desire to figure stuff out.

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These people are content to possess information, but they don’t seek knowledge. Information is what you need to make money short term. Knowledge is the deeper understanding of how things work. It’s obtained only by long and inefficient study. It’s gained by those who set aside the profit motive and instead possess an intrinsic desire just to know.
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Related book: Flash Boys


[H/T Dan]

Greenlight Capital Q1 2014 Letter

We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year. Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it. 
In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:
  • The rejection of conventional valuation methods;
  • Short-sellers forced to cover due to intolerable mark-to-market losses; and
  • Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.
And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?

Given the enormous stock price volatility, we decided to short a basket of bubble stocks. A basket approach makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly. The corollary to “twice a silly price is not twice as silly” is that when the prices reconnect to traditional valuation methods, the derating can be substantial. There is a huge gap between the bubble price and the point where isciplined growth investors (let alone value investors) become interested buyers. When the last internet bubble popped, Cisco (the best of the best bubble stocks) fell 89%, Amazon fell 93%, and the lower quality stocks fell even more.

In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet. Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.

Tuesday, April 22, 2014

Wal-Mart in 1974

A great blog post from Philosophical Economics, and a great example of some of the things Sanjay Bakshi stresses, as well as one of the best examples of what Charlie Munger meant when he said: “"...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."


On Thursday, October 3, 1974, the S&P 500 closed at 62, the definitive closing low of the brutal 1973-1974 bear market.  The trailing twelve month PE ratio for the index at the time was 6.9. The yield on the 10 year treasury bond was 7.9%, and the Fed Funds Rate was 10%.

On that day, Wal-Mart Stores (NYSE: WMT) closed at $12.  Its EPS for the prior fiscal year was $0.93.  Its trailing PE ratio on that number was 12.9.

Here is a link to Wal-Mart’s annual report for FY 1974.  It’s a fun read–you’ll probably learn more about Wal-Mart’s core business reading this report than you will reading the 2013 report.  I doubt that I would have spotted the gem of Wal-Mart had I been investing in 1974, but in reading the report in hindsight, it seems clear that this was an extremely well-run business.

From October 3, 1974, until present, the S&P 500 produced a nominal total return of roughly 12% per year.  With dividends reinvested, a $10,000 investment in the S&P 500 went on to become roughly $900,000.  In that same period, Wal-Mart produced a nominal total return of roughly 23% per year. With dividends reinvested, a $10,000 investment in $WMT went on to become roughly $45,000,000.  That same investment now pays more than $1,000,000 each year in annual dividends–100 times the initial price. 

   
The reason that Wal-Mart produced a fantastic return from 1974 to now is not that it was cheap relative to its present or near-term future earnings.  By the standards of 1974, it was actually a growth stock–priced at almost twice the market multiple.  In the current market, an equivalent valuation would be something like 30 or 40 times earnings–for a business with uncomplicated earnings that had already been in operation in Arkansas for three decades.  It produced a fantastic return because it was a fantastic business, with miles and miles of growth still in front of it.

Suppose that we put $10,000 into your pocket and teleport you back in time, onto the floor of the NYSE at 1PM on Thursday, October 3, 1974.   You know what you know now, and you can buy whatever stock you want to buy.  When the market closes, we’re going to teleport you back to the present, and your $10,000 investment will have turned into whatever it would have turned into, from then until today.

What are you going to buy?  If you’re smart, you’re obviously going to buy $WMT–as much of it as you possibly can. You haven’t looked at any other names, therefore you can’t be sure of their performance.  Exxon? Coca-Cola? You would equal perform the market. IBM? You would dramatically underperform.  The only present-day blue-chip company that I can think of that would have even come close to matching Wal-Mart’s performance is Walgreen (WAG: NYSE).  In $WAG, a $10,000 investment in 1974 would have turned into $10,000,000.

Now, what is the maximum price that you should be willing to pay for $WMT, knowing what it’s going to become?  And what sort of valuation would this price imply?  One way to answer the question would be to discount $WMT’s total return from 1974 to today at the rate of return of the overall market.  $WMT at $12 produced a 40 year annual total return of 23%.  It turns out that the price that would bring this return down to the market rate, 12%, is roughly $600.

In 1974, $600 for a $WMT share would have represented a PE ratio of more than 600.  In the current market, which is much richer, this would be the equivalent of something like 1500 times trailing earnings–again for a company with undistorted earnings that has been in operation for decades.

To account for risk and uncertainty, which doesn’t exist for you, but does exist for anyone that’s not traveling through time, suppose that we cut our $600 maximum fair price for $WMT by 90%. Then we cut it in half. Then we cut it in half again. Normalized to the 2014 market, the multiple would still be roughly 40 times earnings. Many people would balk at such a “rich” price–but for $WMT, it arguably would have been, and arguably actually was, the single greatest buying opportunity of that generation.

The next time we see an excellent business trading at 40 times earnings, or 75 times earnings, or 100 times earnings, or wherever, and we shy away, it might help to remember the example of Wal-Mart. High multiples can be entirely justified, provided that the growth potential is real.  We definitely should remember the example if we ever come under the temptation to short individual names based on valuation concerns.  Nothing is riskier or more imprudent than to short a high-quality business with an uptrending stock price, simply because we think the price is too high.  It can always go higher–often, it will go higher, for fundamentally valid reasons that we’ve failed to appreciate.

Tim Ferriss interviews Josh Waitzkin

Link to podcast: Episode 2: Joshua Waitzkin

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Related book: The Art of Learning: An Inner Journey to Optimal Performance

Ben Horowitz on Charlie Rose

Monday, April 21, 2014

Cosmos: A Spacetime Odyssey: The Clean Room (Episode 7)


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Carl Sagan’s daughter also just wrote a nice article for New York Magazine

Then he told me, very tenderly, that it can be dangerous to believe things just because you want them to be true. You can get tricked if you don’t question yourself and others, especially people in a position of authority. He told me that anything that’s truly real can stand up to scrutiny. 
As far as I can remember, this is the first time I began to understand the permanence of death. As I veered into a kind of mini existential crisis, my parents comforted me without deviating from their scientific worldview. 
“You are alive right this second. That is an amazing thing,” they told me. When you consider the nearly infinite number of forks in the road that lead to any single person being born, they said, you must be grateful that you’re you at this very second. Think of the enormous number of potential alternate universes where, for example, your great-great-grandparents never meet and you never come to be. Moreover, you have the pleasure of living on a planet where you have evolved to breathe the air, drink the water, and love the warmth of the closest star. You’re connected to the generations through DNA — and, even farther back, to the universe, because every cell in your body was cooked in the hearts of stars. We are star stuff, my dad famously said, and he made me feel that way. 
My parents taught me that even though it’s not forever — because it’s not forever — being alive is a profoundly beautiful thing for which each of us should feel deeply grateful. If we lived forever it would not be so amazing.
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Related links:


[H/T Lincoln] These 1977 Christmas Lectures are similar to the 1991 Christmas Lectures by Richard Dawkins, HERE, which discussed evolution.

Hoisington Q1 2014 Letter

The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger. The preponderance of research suggests that the FOMC has been incorrect in its presumption of the effectiveness of quantitative easing (QE) on boosting economic growth. This faulty track record calls into question their latest prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015. 
A major reason for the FOMC’s overly optimistic forecast for economic growth and its incorrect view of the effectiveness of quantitative easing is the reliance on the so-called “wealth effect”, described as a change in consumer wealth which results in a change in consumer spending.