Monday, March 2, 2015

Berkshire Hathaway's stock price performance in the past

Berkshire Hathaway included the yearly stock performance in the annual report this year. After slower growth in book value in the 1973-1974 recession, book value growth picked up in 1975. Berkshire's stock price, which was down a bit in 1973, took a beating along with the whole market in 1974. Then, after only a slight gain in 1975, the stock went on to average gains of over 55% per year in the 10 years from 1976 to 1985, and over 44% per year in the 20 years from 1976 to 1995.

Below are some of the beginning excerpts to the letters from those earlier years. Note: The actual gains in book value here are different than Berkshire reports in its recent letter because mark-to-market accounting rules changed, and Berkshire made previous years conform for comparison purposes.

Operating results for 1974 overall were unsatisfactory due to the poor performance of our insurance business. In last year's annual report some decline in profitability was predicted but the extent of this decline, which accelerated during the year, was a surprise. Operating earnings for 1974 were $8,383,576, or $8.56 per share, for a return on beginning shareholders' equity of 10.3%. This is the lowest return on equity realized since 1970. Our textile division and our bank both performed very well, turning in improved results against the already good figures of 1973. However, insurance underwriting, which has been mentioned in the last several annual reports as running at levels of unsustainable profitability, turned dramatically worse as the year progressed. 
The outlook for 1975 is not encouraging. We undoubtedly will have sharply negative comparisons in our textile operation and probably a moderate decline in banking earnings. Insurance underwriting is a large question mark at this time—it certainly won't be a satisfactory year in this area, and could be an extremely poor one. Prospects are reasonably good for an improvement in both insurance investment income and our equity in earnings of Blue Chip Stamps. During this period we plan to continue to build financial strength and liquidity, preparing for the time when insurance rates become adequate and we can once again aggressively pursue opportunities for growth in this area.
Last year, when discussing the prospects for 1975, we stated “the outlook for 1975 is not encouraging.” This forecast proved to be distressingly accurate. Our operating earnings for 1975 were $6,713,592, or $6.85 per share, producing a return on beginning shareholders’ equity of 7.6%. This is the lowest return on equity experienced since 1967. Furthermore, as explained later in this letter, a large segment of these earnings resulted from Federal income tax refunds which will not be available to assist performance in 1976.
On balance, however, current trends indicate a somewhat brighter 1976. Operations and prospects will be discussed in greater detail below, under specific industry titles. Our expectation is that significantly better results in textiles, earnings added from recent acquisitions, an increase in equity in earnings of Blue Chip Stamps resulting from an enlarged ownership interest, and at least a moderate improvement in insurance underwriting results will more than offset other possible negatives to produce greater earnings in 1976. The major variable—and by far the most difficult to predict with any feeling of confidence—is the insurance underwriting result. Present very tentative indications are that underwriting improvement is in prospect. If such improvement is moderate, our overall gain in earnings in 1976 likewise will prove moderate. More significant underwriting improvement could give us a major gain in earnings.
After two dismal years, operating results in 1976 improved significantly. Last year we said the degree of progress in insurance underwriting would determine whether our gain in earnings would be “moderate” or “major.” As it turned out, earnings exceeded even the high end of our expectations. In large part, this was due to the outstanding efforts of Phil Liesche’s managerial group at National Indemnity Company. 
In dollar terms, operating earnings came to $16,073,000, or $16.47 per share. While this is a record figure, we consider return on shareholders’ equity to be a much more significant yardstick of economic performance. Here our result was 17.3%, moderately above our long-term average and even further above the average of American industry, but well below our record level of 19.8% achieved in 1972. 
Our present estimate, subject to all the caveats implicit in forecasting, is that dollar operating earnings are likely to improve somewhat in 1977, but that return on equity may decline a bit from the 1976 figure.


The 1982 article on Jimmy Ling recommended by Warren Buffett in his shareholder letter (LINK)

Carol Loomis: Grading Berkshire after 50 years under Buffett: How does a 1,826,163% stock rise sound? (LINK)

A Dozen Things Taught by Warren Buffett in his 50th Anniversary Letter that will Benefit Ordinary Investors (LINK)

18 Lessons for Investors and Managers from Warren Buffett’s 2014 Letter to Shareholders (LINK)

"60 Minutes" found that Lumber Liquidators' Chinese-made laminate flooring contains amounts of toxic formaldehyde that may not meet health and safety standards (LINK)

Value Investing Podcast: Paul Lountzis on Value Investing (LINK)

Regression to the Mean and Value Investing [H/T csinvesting] (LINK)

Quick Thoughts on Portfolio Strategy - by Chris Pavese (LINK)

Mutual Fund Observer, March 2015 (LINK)
So I say again, focus upon your time horizons and risk tolerance. If your investment pool represents the accumulation of your life’s work and retirement savings, your focus should be not on how much you can make but rather how much you can afford to lose. As the U.S. equity market has continued to hit one record high after another,  recognize that it is getting close to trading at nearly thirty times long-term, inflation-adjusted earnings. In 2014, the S&P 500 did not fall for more than three consecutive days. 
We are in la-la land, and there is little margin for error in most investment opportunities. On January 15, 2015, when the Swiss National Bank eliminated its currency’s Euro-peg, the value of that currency moved 30% in minutes, wiping out many currency traders in what were thought to be low-risk arbitrage-like investments. 
What should this mean for readers of this publication? We at MFO have been looking for absolute value investors. I can tell you that they are in short supply. Charlie Munger had some good advice recently, which others have quoted and I will paraphrase. Focus on doing the easy things. Investment decisions or choices that are complex, and by that I mean things that include shorting stocks, futures, and the like – leave that to others. One of the more brilliant value investors and a contemporary of Benjamin Graham, Irving Kahn, passed away last week. He did very well with 50% of his assets in cash and 50% of his assets in equities. For most of us, the cash serves as a buffer and as a reserve for when the real, once in a lifetime, opportunities arise. I will close now, as is my wont, with a quote from a book, The Last Supper, by one of the great, under-appreciated American authors, Charles McCarry. “Do you know what makes a man a genius? The ability to see the obvious. Practically nobody can do that.”
Hussman Weekly Market Comment: Plan to Exit Stocks Within the Next 8 Years? Exit Now (LINK)
Last week, the cyclically-adjusted P/E of the S&P 500 Index surpassed 27, versus a historical norm of just 15 prior to the late-1990’s market bubble. The S&P 500 price/revenue ratio surpassed 1.8, versus a pre-bubble norm of just 0.8. On a wide range of historically reliable measures (having a nearly 90% correlation with actual subsequent S&P 500 total returns), we estimate current valuations to be fully 118% above levels associated with historically normal subsequent returns in stocks. Advisory bullishness (Investors Intelligence) shot to 59.5%, compared with only 14.1% bears – one of the most lopsided sentiment extremes on record. The S&P 500 registered a record high after an advancing half-cycle since 2009 that is historically long-in-the-tooth and already exceeds the valuation peaks set at every cyclical extreme in history but 2000 on the S&P 500 (across all stocks, current median price/earnings, price/revenue and enterprise value/EBITDA multiples already exceed the 2000 extreme). Equally important, our measures of market internals and credit spreads, despite moderate improvement in recent weeks, continue to suggest a shift toward risk-aversion among investors. An environment of compressed risk premiums coupled with increasing risk-aversion is without question the most hostile set of features one can identify in the historical record.
Amazon’s Twitch Site Bets on Poker (LINK)

Meet the man who could own Aviva France (LINK)
When he was seven years old, Max-HervĂ© George was given a magic ticket by his father. It lets him turn back the clock, to invest with perfect hindsight week after week, steadily accumulating a fortune. 
The ticket is a life insurance contract and Mr George, now 25, has fought for years in the French courts to preserve its magic. He could be a billionaire by the end of this decade and, by the end of the next, his contract would be worth more than the insurance company which stands behind it, Aviva France. 
There is no mystery to the financial magic, however. Instead it is a story of grand stupidity, of how a French insurer wrote the worst contract in the world and sold it to thousands of clients.
How To Deal With Email After A Long Vacation (LINK)

Book of the day, which was recommended by Nick Gogerty in his interview with Jake Taylor: The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else

Warren Buffett on CNBC

Links to videos:

Berkshire Hathaway celebrates 50 years

Who will succeed Warren Buffett?

#Ask Warren: Charlie Munger

No surprises at IBM: Buffett

Deere's long term attraction: Buffett

#Ask Warren: Glenn Close

What's inside Berkshire Hathaway?

Hints of 'Jain & Abel' in Berkshire's annual letter

Buffett on AmEx: We love it

Buffett: 2% economy not bad

Buffett on dividends and buybacks

LeBron James asks Buffett for investment tips

#Ask Warren: Decision 2016

Buffett's no holds barred shareholder letter

Buffett: Mary Barra right for GM [Buffett's usual technique of not criticizing by name goes a bit by the wayside at the end of this clip, where he calls out David Winters and his fund's performance in relation to what Winters makes in management fees.]

#Ask Warren: Europe [Another Munger question for Buffett.]

#Ask Warren: Arnold Schwarzenegger

Buffett: I would have passed Keystone

Buffett's advice for the next 50 years

Sunday, March 1, 2015

A few comments on the Berkshire Hathaway letter to shareholders

We got a nice treat this year with the “Golden Anniversary” letters included in the Berkshire report. While much of what was written had been mentioned by Buffett and Munger before, there were also new things, as well as some things that especially stood out to me that, while they may have been said to some extent before, made me think harder about than I previously remember.

One of those major things was the importance of reinvestment. And both Buffett and Munger's comments reminded me of this answer Tom Gayner gave at a Value Investor Conference last year:
Over the years, we’ve consistently discussed our four part investment process of searching for profitable businesses with good returns on capital, run by honest and talented management teams, with reinvestment opportunities [and] capital discipline, at fair prices. I believe that each and every word of that distilled statement packs incredible freight. As such, I’m reluctant to pick any single notion as more or less important than another. They all tie together.

That said, if you held a gun to my head and said which of the four ideas is most important, I would respond with point #3, reinvestment opportunities and capital discipline.

One of the reasons that I propose such a simplification is that the idea of reinvestment and capital discipline embeds the other concepts. If the business is not profitable, there is no money to reinvest. If the management team is not talented and honest, there will either be no money to reinvest or it will be hived off by the management before it ever gets to the shareholders. And finally, and this is the most nuanced and misunderstood aspect of investing, a fair price may be a lot more than you would think if profitable reinvestment really can take place.
Buffett made the point that having the flexibility to invest anywhere is one of the major advantages of Berkshire's conglomerate structure:
In effect, the world is Berkshire’s oyster – a world offering us a range of opportunities far beyond those realistically open to most companies. We are limited, of course, to businesses whose economic prospects we can evaluate. And that’s a serious limitation: Charlie and I have no idea what a great many companies will look like ten years from now. But that limitation is much smaller than that borne by an executive whose experience has been confined to a single industry. On top of that, we can profitably scale to a far larger size than the many businesses that are constrained by the limited potential of the single industry in which they operate.

I mentioned earlier that See’s Candy had produced huge earnings compared to its modest capital requirements. We would have loved, of course, to intelligently use those funds to expand our candy operation. But our many attempts to do so were largely futile. So, without incurring tax inefficiencies or frictional costs, we have used the excess funds generated by See’s to help purchase other businesses. If See’s had remained a stand-alone company, its earnings would have had to be distributed to investors to redeploy, sometimes after being heavily depleted by large taxes and, almost always, by significant frictional and agency costs.
And it also reminded me of something I have included in a file of investment reminders and thoughts that I keep around to review regularly. This is a particular reminder I have about compounders not just being businesses that can internally reinvest, but also management teams that have the flexibility to reinvest in other places:
Compounders can also be managers or investment teams that reinvest cash flows or float at a healthy rate of return, in a flexible manner…. But keep in mind that these are very hard to identify ahead of time, it can be easy to be fooled by people, and that a bad business can overwhelm even the best operators and capital allocators.
And as Buffett especially stressed in his letter, Berkshire was certainly a bad business when he took over. But besides the fact that he may have been, and continues to be, an extra special capital allocator, his drive (and maybe a little luck along the way) to continue to reinvest in himself and get a little wiser every day is what helped to propel Berkshire beyond the headwind of a bad business. And I think Munger made this point well when describing the system set up at Berkshire, whereas Chairman Buffett made sure that:
His first priority would be reservation of much time for quiet reading and thinking, particularly that which might advance his determined learning, no matter how old he became; and
He would also spend much time in enthusiastically admiring what others were accomplishing.
...When Buffett developed the Berkshire system, did he foresee all the benefits that followed? No. Buffett stumbled into some benefits through practice evolution. But, when he saw useful consequences, he strengthened their causes.
Munger then goes on to list many other factors which I won't rehash here, but they are so applicable to most businesses and other areas of life that they will be something I plan on revisiting often. And they include more thoughts on reinvestment, and in one case an example of missing out on investing in a company with a long road of reinvestment prospects in place:
What were the big mistakes made by Berkshire under Buffett? Well, while mistakes of commission were common, almost all huge errors were in not making a purchase, including not purchasing Walmart stock when that was sure to work out enormously well. The errors of omission were of much importance. Berkshire’s net worth would now be at least $50 billion higher if it had seized several opportunities it was not quite smart enough to recognize as virtually sure things.
One other comment from Buffett got me thinking about the commentary I had on diversification and the Kelly Formula recently:
I believe that the chance of permanent capital loss for patient Berkshire shareholders is as low as can be found among single-company investments. That’s because our per-share intrinsic business value is almost certain to advance over time.
This drove home the point to me of how much big position sizes are favored by good businesses that growth their per-share intrinsic business value over time. I mentioned I thought 6-12 position sizes is probably a good number of core positions for the value investor who puts significant effort in choosing his or her investments. Now, at the concentrated end of that, you'd have 16.67% position sizes if fully invested equally. If you're leaving some margin of safety for error, the unknown unknowns, or because of opportunity costs, maybe you're only "betting" 1/2 Kelly on a given position. Which means that you'd need a fully Kelly position to tell you that you should be putting 1/3 of your portfolio in something before committing 16.67% to it at 1/2 Kelly.

What upside vs. downside gives you that output? If you're assuming 50/50 odds of being right (which is hopefully conservative), then you'd need a 3x upside vs. downside ratio over your investing timeframe before investing. As we've seen and as Buffett and Munger stressed, even Berkshire has been about halved three times since 1965. And while that wasn't permanent of course, if you assume your downside on a given in investment is around 50%, then you'd need 150% of upside (i.e. more than a double) in order for that bet to be worth taking. And it's hard to find that kind of potential in a company that isn't growing its value over time. And if you take the potential downside to be complete loss of capital (i.e. 100% downside), then 150% of upside would give you a full Kelly position size equal to the 16.67% number, and a 1/2 Kelly position size then at 8.33%.

And the key to that growth being growth in per-share intrinsic business value because not all growth creates value, which was also shown, to some extent, in one example by Buffett of things that he, in his Buffett Partnership days as well as at Berkshire, hasn't done:
At both BPL and Berkshire, we have never invested in companies that are hell-bent on issuing shares. That behavior is one of the surest indicators of a promotion-minded management, weak accounting, a stock that is overpriced and – all too often – outright dishonesty.
And a final excerpt from Mr. Buffett, which is too good not to repeat:
My successor will need one other particular strength: the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency. When these corporate cancers metastasize, even the strongest of companies can falter.

Friday, February 27, 2015


Eddie Lampert's letter to shareholders  (LINK)

Five Good Questions for Nick Gogerty about his book, The Nature of Value: How to Invest in the Adaptive Economy (LINK)

Dan Carlin's Common Sense podcast from last week, discussing Russia and Ukraine (audio) (LINK)

Book of the day: At Home: A Short History of Private Life - by Bill Bryson

And as a reminder, Warren Buffett’s 2014 annual letter to shareholders will be released at approximately 8:00 a.m. eastern time tomorrow, with comments from both Buffett and Munger regarding Berkshire's first 50 years.

Charlie Munger on buying "moats"

"We buy barriers. Building them is tough… Our great brands aren’t anything we’ve created. We’ve bought them. If you’re buying something at a huge discount to its replacement value and it is hard to replace, you have a big advantage. One competitor is enough to ruin a business running on small margins." -Charlie Munger 

[H/T 25iq]

Thursday, February 26, 2015


Value Investing Community Loses a Legend: Irving Kahn (1905 – 2015) (LINK)

Webinar: Portfolio Construction, Concentration and Diversification for Value Investors - By Tobias Carlisle (LINK) ["If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification... If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice... Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up." -Warren Buffett]
Related recent post: A quick diversification thought...
Baupost Details Risk Management, Hedging In Q4 Letter (LINK)

Money creation in the modern economy (LINK)
This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
The Brooklyn Investor: PM Investor Day 2015 (LINK)

Paul Graham: What Microsoft Is this the Altair Basic of? (LINK)
One of the most valuable exercises you can try if you want to understand startups is to look at the most successful companies and explain why they were not as lame as they seemed when they first launched. Because they practically all seemed lame at first. Not just small, lame. Not just the first step up a big mountain. More like the first step into a swamp.

A Basic interpreter for the Altair? How could that ever grow into a giant company? People sleeping on airbeds in strangers' apartments? A web site for college students to stalk one another? A wimpy little single-board computer for hobbyists that used a TV as a monitor? A new search engine, when there were already about 10, and they were all trying to de-emphasize search? These ideas didn't just seem small. They seemed wrong. They were the kind of ideas you could not merely ignore, but ridicule.

Often the founders themselves didn't know why their ideas were promising. They were attracted to these ideas by instinct, because they were living in the future and they sensed that something was missing. But they could not have put into words exactly how their ugly ducklings were going to grow into big, beautiful swans.
Book of the day (H/T Graham & Doddsville): Storage and Stability

Stay with simple propositions...

Excerpt from Warren Buffett's 2004 letter:
Last year MidAmerican wrote off a major investment in a zinc recovery project that was initiated in 1998 and became operational in 2002. Large quantities of zinc are present in the brine produced by our California geothermal operations, and we believed we could profitably extract the metal. For many months, it appeared that commercially-viable recoveries were imminent. But in mining, just as in oil exploration, prospects have a way of “teasing” their developers, and every time one problem was solved, another popped up. In September, we threw in the towel.

Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for – if you’ll excuse an oxymoron – mono-linked chains.
It also reminded me of this excerpt, and similar lesson, from his 2008 letter:
I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.

Wednesday, February 25, 2015


Donald R. Keough, Who Led Coca-Cola Through New Coke Debacle, Dies at 88 (LINK)
In his 2008 Times interview, Mr. Keough spoke about a lesson he learned from working in the stockyards of Sioux City, Iowa. 
“When I was 15 or 16 years old, I got a job buying bulls to ship to processing plants back East,” he said. “I worked for a man named Doyle Harmon, and my first day on the job, he chastised me for paying too much. He said, ‘Concentrate on the bull, not on the language of selling.’ I’ve made most of the mistakes in my career by not concentrating on the bull.”
Warren Buffett's German To-Do List [H/T Peter] (LINK)

Joel Greenblatt on CNBC (video) [H/T ValueWalk] (LINK)

Patient Capital Management Q4 2014 Investor Letter (LINK)

Andrew Smithers: The sustainable growth of the US (LINK)

I hadn't realized it until now, but besides supporting this blog by shopping through our Amazon link (HERE), you can now also support the blog by signing up for a free trial with Audible using THIS link (there's also a banner on the right site of our homepage that links to it). The trial includes two free audiobooks. I've found that if you get a good narration of the book, listening can be an even better experience than reading a particular book.