Saturday, February 28, 2009

Warren Buffett's 2008 Shareholder Letter

Warren Buffett's 2008 Letter to the Shareholders of Berkshire Hathaway Inc.



The table on the preceding page, recording both the 44-year performance of Berkshire’s book value and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”

By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.

Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges.

Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.

Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.

Friday, February 27, 2009

Thursday, February 26, 2009

James Montier’s CIMA Presentation

Yet another link that I discovered on my friend Miguel's blog, Simoleon Sense, which is my favorite blog out there (no offense to all the other excellent blogs).

Eddie Lampert's Letter to Sears Shareholders

The Adaptive Organization

The pace of change over the past few years and the volatility of the last twelve months seem to have accelerated to the point where businesses and governments are struggling to keep up. In order to drive a strategy one needs to have a context in which that strategy is executed. When oil goes from $50 to $145 and then back to $35 all within a year, what type of strategy can contemplate and manage that? Those who hedged oil purchases looked very smart when oil went up, but when oil declined, some companies experienced huge losses and had to post collateral to maintain those hedges. Nobody wanted to buy trucks last summer and nobody wanted to buy a Toyota Prius in the fall. By winter, nobody wanted to buy any cars or trucks.

As discussed above, during the past year we underwent a major organizational transformation to help us adapt to the accelerated pace of change across all of our businesses. This change goes far beyond economic conditions. New technology and business models have forced many mature industries and businesses to reassess their ability to compete. We put in place boards and leadership teams and developed internal financial reports for each of the business units. We are working to align incentives to close the gap versus industry productivity metrics, as emphasized in our planning process this year. While several steps remain to finalize the processes and systems supporting this structure, we made rapid strides this year in laying the foundation for a more adaptive organization.

In the past, we have described a portfolio approach to managing the business at Sears Holdings. This includes the way we reorganized our business units as well as the way we have invested our capital and managed risk. This is a complicated and complex transition for any company that is used to thinking in a single scenario. For those who don’t agree with the idea of a portfolio approach as the underpinning of strategy, I respectfully disagree. It is easier in theory to manage to a single scenario and a single plan. It is much easier to communicate based on a single scenario and a single plan. But the world is complex and it doesn’t always cooperate. Whether it is changing events on a battlefield, changing events in a sporting contest, or changing events in an industry, being able to adapt and change faster than the competition is a huge advantage.

Wednesday, February 25, 2009

Fairholme Conference Call

Fairholme Capital Management held a conference call on February 11th, moderated by Bruce Berkowitz:
Audio ---------- Transcript

Tuesday, February 24, 2009

Finding Quality Management in the Micro-Cap World

I wrote an article for GuruFocus about a few management teams that I think are of high quality in the micro-cap world: HERE

Monday, February 23, 2009

Ben Franklin - 3 Essays - The Ephemera; The Whistle; Franklin and the Gout

Below are three of my favorite Ben Franklin essays that I think are worth going back and occasionally re-reading.

I. The Ephemera: An Emblem of Human Life

Benjamin Franklin (1706–1790)

To Madame Brillon, of Passy

YOU may remember, my dear friend, that when we lately spend that happy day in the delightful garden and sweet society of the Moulin Joly, I stopped a little in one of our walks, and stayed some time behind the company. We had been shown numberless skeletons of a kind of little fly, called an ephemera, whose successive generations, we were told, were bred and expired within the day. I happened to see a living company of them on a leaf, who appeared to be engaged in conversation. You know I understand all the inferior animal tongues. My too great application to the study of them is the best excuse I can give for the little progress I have made in your charming language. I listened through curiosity to the discourse of these little creatures; but as they, in their national vivacity, spoke three or four together, I could make but little of their conversation. I found, however, by some broken expressions that I heard now and then, they were disputing warmly on the merit of two foreign musicians, one a cousin, the other a moscheto; in which dispute they spent their time, seemingly as regardless of the shortness of life as if they had been sure of living a month. Happy people! thought I; you are certainly under a wise, just, and mild government, since you have no public grievances to complain of, nor any subject of contention but the perfections and imperfections of foreign music. I turned my head from them to an old gray-headed one, who was single on another leaf, and talking to himself. Being amused with his soliloquy, I put it down in writing, in hopes it will likewise amuse her to whom I am so much indebted for the most pleasing of all amusements, her delicious company and heavenly harmony.

“It was,” said he, “the opinion of learned philosophers of our race, who lived and flourished long before my time, that this vast world, the Moulin Joly, could not itself subsist more than eighteen hours; and I think there was some foundation for that opinion, since, by the apparent motion of the great luminary that gives life to all nature, and which in my time has evidently declined considerably towards the ocean at the end of our earth, it must then finish its course, be extinguished in the waters that surround us, and leave the world in cold and darkness, necessarily producing universal death and destruction. I have lived seven of those hours, a great age, being no less than four hundred and twenty minutes of time. How very few of us continue so long! I have seen generations born, flourish, and expire. My present friends are the children and grandchildren of the friends of my youth, who are now, also, no more! And I must soon follow them; for, by the course of nature, though still in health, I cannot expect to live above seven or eight minutes longer. What now avails all my toil and labor in amassing honey-dew on this leaf, which I cannot live to enjoy! What the political struggles I have been engaged in for the good of my compatriot inhabitants of this bush, or my philosophical studies for the benefit of our race in general! for in politics what can laws do without morals? Our present race of ephemera will in a course of minutes become corrupt, like those of other and older bushes, and consequently as wretched. And in philosophy how small our progress! Alas! art is long, and life is short! My friends would comfort me with the idea of a name they say I shall leave behind me; and they tell me I have lived long enough to nature and to glory. But what will fame be to an ephemera who no longer exists? And what will become of all history in the eighteenth hour, when the world itself, even the whole Moulin Joly, shall come to its end and be buried in universal ruin?”

To me, after all my eager pursuits, no solid pleasures now remain, but the reflection of a long life spent in meaning well, the sensible conversation of a few good lady ephemeræ, and now and then a kind smile and a tune from the ever amiable Brillante.



II. The Whistle

Benjamin Franklin (1706–1790)

To Madame Brillon

I RECEIVED my dear friend’s two letters, one for Wednesday and one for Saturday. This is again Wednesday. I do not deserve one for to-day, because I have not answered the former. But, indolent as I am, and averse to writing, the fear of having no more of your pleasing epistles, if I do not contribute to the correspondence, obliges me to take up my pen; and as Mr. B. has kindly sent me word that he sets out to-morrow to see you, instead of spending this Wednesday evening, as I have done its namesakes, in your delightful company, I sit down to spend it in thinking of you, in writing to you, and in reading over and over again your letters.

I am charmed with your description of Paradise, and with your plan of living there; and I approve much of your conclusion, that, in the meantime, we should draw all the good we can from this world. In my opinion we might all draw more good from it than we do, and suffer less evil, if we would take care not to give too much for whistles. For to me it seems that most of the unhappy people we meet with are become so by neglect of that caution.

You ask what I mean? You love stories, and will excuse my telling one of myself.

When I was a child of seven years old, my friends, on a holiday, filled my pocket with coppers. I went directly to a shop where they sold toys for children; and being charmed with the sound of a whistle, that I met by the way in the hands of another boy, I voluntarily offered and gave all my money for one. I then came home, and went whistling all over the house, much pleased with my whistle, but disturbing all the family. My brothers, and sisters, and cousins, understanding the bargain I had made, told me I had given four times as much for it as it was worth; put me in mind what good things I might have bought with the rest of the money; and laughed at me so much for my folly, that I cried with vexation; and the reflection gave me more chagrin than the whistle gave me pleasure.

This, however, was afterwards of use to me, the impression continuing on my mind; so that often, when I was tempted to buy some unnecessary thing, I said to myself, Don’t give too much for the whistle; and I saved my money.

As I grew up, came into the world, and observed the actions of men, I thought I met with many, very many, who gave too much for the whistle.

When I saw one too ambitious of court favor, sacrificing his time in attendance on levees, his repose, his liberty, his virtue, and perhaps his friends, to attain it, I have said to myself, This man gives too much for his whistle.

When I saw another fond of popularity, constantly employing himself in political bustles, neglecting his own affairs, and ruining them by that neglect, He pays, indeed, said I, too much for his whistle.

If I knew a miser, who gave up every kind of comfortable living, all the pleasure of doing good to others, all the esteem of his fellow-citizens, and the joys of benevolent friendship, for the sake of accumulating wealth, Poor man, said I, you pay too much for your whistle.

When I met with a man of pleasure, sacrificing every laudable improvement of the mind, or of his fortune, to mere corporeal sensations, and ruining his health in their pursuit, Mistaken man, said I, you are providing pain for yourself, instead of pleasure; you give too much for your whistle.

If I see one fond of appearance, or fine clothes, fine houses, fine furniture, fine equipages, all above his fortune, for which he contracts debts, and ends his career in a prison, Alas! say I, he has paid dear, very dear, for his whistle.

When I see a beautiful sweet-tempered girl married to an ill-natured brute of a husband, What a pity, say I, that she should pay so much for a whistle!

In short, I conceive that great part of the miseries of mankind are brought upon them by the false estimates they have made of the value of things, and by their giving too much for their whistles.

Yet I ought to have charity for these unhappy people, when I consider that, with all this wisdom of which I am boasting, there are certain things in the world so tempting, for example, the apples of King John, which happily are not to be bought; for if they were put to sale by auction, I might very easily be led to ruin myself in the purchase, and find that I had once more given too much for the whistle.

Adieu, my dear friend, and believe me ever yours very sincerely and with unalterable affection.



III. Dialogue Between Franklin and the Gout

Benjamin Franklin (1706–1790)

Midnight, 22 October, 1780.

FRANKLIN. Eh! Oh! eh! What have I done to merit these cruel sufferings?

GOUT. Many things; you have ate and drank too freely, and too much indulged those legs of yours in their indolence.

FRANKLIN. Who is it that accuses me?

GOUT. It is I, even I, the Gout.

FRANKLIN. What! my enemy in person?

GOUT. No, not your enemy.

FRANKLIN. I repeat it, my enemy; for you would not only torment my body to death, but ruin my good name; you reproach me as a glutton and a tippler; now all the world, that knows me, will allow that I am neither the one nor the other.

GOUT. The world may think as it pleases; it is always very complaisant to itself, and sometimes to its friends; but I very well know that the quantity of meat and drink proper for a man, who takes a reasonable degree of exercise, would be too much for another, who never takes any.

FRANKLIN. I take—eh! oh!—as much exercise—eh!—as I can, Madam Gout. You know my sedentary state, and on that account, it would seem, Madam Gout, as if you might spare me a little, seeing it is not altogether my own fault.

GOUT. Not a jot; your rhetoric and your politeness are thrown away; your apology avails nothing. If your situation in life is a sedentary one, your amusements, your recreation, at least, should be active. You ought to walk or ride; or, if the weather prevents that, play at billiards. But let us examine your course of life. While the mornings are long, and you have leisure to go abroad, what do you do? Why, instead of gaining an appetite for breakfast, by salutary exercise, you amuse yourself with books, pamphlets, or newspapers, which commonly are not worth the reading. Yet you eat an inordinate breakfast, four dishes of tea, with cream, and one or two buttered toasts, with slices of hung beef, which I fancy are not things the most easily digested. Immediately afterwards you sit down to write at your desk, or converse with persons who apply to you on business. Thus the time passes till one, without any kind of bodily exercise. But all this I could pardon, in regard, as you say, to your sedentary condition. But what is your practice after dinner? Walking in the beautiful gardens of those friends with whom you have dined would be the choice of men of sense; yours is to be fixed down to chess, where you are found engaged for two or three hours! This is your perpetual recreation, which is the least eligible of any for a sedentary man, because, instead of accelerating the motion of the fluids, the rigid attention it requires helps to retard the circulation and obstruct internal secretions. Wrapt in the speculations of this wretched game, you destroy your constitution. What can be expected from such a course of living, but a body replete with stagnant humors, ready to fall prey to all kinds of dangerous maladies, if I, the Gout, did not occasionally bring you relief by agitating those humors, and so purifying or dissipating them? If it was in some nook or alley in Paris, deprived of walks, that you played awhile at chess after dinner, this might be excusable; but the same taste prevails with you in Passy, Auteuil, Montmartre, or Sanoy, places where there are the finest gardens and walks, a pure air, beautiful women, and most agreeable and instructive conversation; all which you might enjoy by frequenting the walks. But these are rejected for this abominable game of chess. Fie, then, Mr. Franklin! But amidst my instructions, I had almost forgot to administer my wholesome corrections; so take that twinge,—and that.

FRANKLIN. Oh! eh! oh! Ohhh! As much instruction as you please, Madam Gout, and as many reproaches; but pray, Madam, a truce with your corrections!

GOUT. No, Sir, no,—I will not abate a particle of what is so much for your good,—therefore—

FRANKLIN. Oh! ehhh!—It is not fair to say I take no exercise, when I do very often, going out to dine and returning in my carriage.

GOUT. That, of all imaginable exercises, is the most slight and insignificant, if you allude to the motion of a carriage suspended on springs. By observing the degree of heat obtained by different kinds of motion, we may form an estimate of the quantity of exercise given by each. Thus, for example, if you turn out to walk in winter with cold feet, in an hour’s time you will be in a glow all over; ride on horseback, the same effect will scarcely be perceived by four hours’ round trotting; but if you loll in a carriage, such as you have mentioned, you may travel all day and gladly enter the last inn to warm your feet by a fire. Flatter yourself then no longer, that half an hour’s airing in your carriage deserves the name of exercise. Providence has appointed few to roll in carriages, while he has given to all a pair of legs, which are machines infinitely more commodious and serviceable. Be grateful, then, and make a proper use of yours. Would you know how they forward the circulation of your fluids, in the very action of transporting you from place to place; observe when you walk, that all your weight is alternately thrown from one leg to the other; this occasions a great pressure on the vessels of the foot, and repels their contents; when relieved, by the weight being thrown on the other foot, the vessels of the first are allowed to replenish, and, by a return of this weight, this repulsion again succeeds; thus accelerating the circulation of the blood. The heat produced in any given time depends on the degree of this acceleration; the fluids are shaken, the humors attenuated, the secretions facilitated, and all goes well; the cheeks are ruddy, and health is established. Behold your fair friend at Auteuil; a lady who received from bounteous nature more really useful science than half a dozen such pretenders to philosophy as you have been able to extract from all your books. When she honors you with a visit, it is on foot. She walks all hours of the day, and leaves indolence, and its concomitant maladies, to be endured by her horses. In this, see at once the preservative of her health and personal charms. But when you go to Auteuil, you must have your carriage, though it is no farther from Passy to Auteuil than from Auteuil to Passy.

FRANKLIN. Your reasonings grow very tiresome.

GOUT. I stand corrected. I will be silent and continue my office; take that, and that.

FRANKLIN. Oh! Ohh! Talk on, I pray you.

GOUT. No, no; I have a good number of twinges for you to-night, and you may be sure of some more tomorrow.

FRANKLIN. What, with such a fever! I shall go distracted. Oh! eh! Can no one bear it for me?

GOUT. Ask that of your horses; they have served you faithfully.

FRANKLIN. How can you so cruelly sport with my torments

GOUT. Sport! I am very serious. I have here a list of offenses against your own health distinctly written, and can justify every stroke inflicted on you.

FRANKLIN. Read it then.

GOUT. It is too long a detail; but I will briefly mention some particulars.

FRANKLIN. Proceed. I am all attention.

GOUT. Do you remember how often you have promised yourself, the following morning, a walk in the grove of Boulogne, in the garden de la Muette, or in your own garden, and have violated your promise, alleging, at one time, it was too cold, at another too warm, too windy, too moist, or what else you pleased; when in truth it was too nothing, but your insuperable love of ease?

FRANKLIN. That I confess may have happened occasionally, probably ten times in a year.

GOUT. Your confession is very far short of the truth; the gross amount is one hundred and ninety-nine times.

FRANKLIN. Is it possible?

GOUT. So possible, that it is fact; you may rely on the accuracy of my statement. You know M. Brillon’s gardens, and what fine walks they contain; you know the handsome flight of an hundred steps, which lead from the terrace above to the lawn below. You have been in the practice of visiting this amiable family twice a week, after dinner, and it is a maxim of your own, that “a man may take as much exercise in walking a mile, up and down stairs, as in ten on level ground.” What an opportunity was here for you to have had exercise in both these ways! Did you embrace it, and how often?

FRANKLIN. I cannot immediately answer that question.

GOUT. I will do it for you; not once.

FRANKLIN. Not once?

GOUT. Even so. During the summer you went there at six o’ clock. You found the charming lady, with her lovely children and friends, eager to walk with you, and entertain you with their agreeable conversation; and what has been your choice? Why, to sit on the terrace, satisfy yourself with the fine prospect, and passing your eye over the beauties of the garden below, without taking one step to descend and walk about in them. On the contrary, you call for tea and the chess-board; and lo! you are occupied in your seat till nine o’clock, and that besides two hours’ play after dinner; and then, instead of walking home, which would have bestirred you a little, you step into your carriage. How absurd to suppose that all this carelessness can be reconcilable with health, without my interposition!

FRANKLIN. I am convinced now of the justness of Poor Richard’s remark, that “Our debts and our sins are always greater than we think for.”

GOUT. So it is. You philosophers are sages in your maxims, and fools in your conduct.

FRANKLIN. But do you charge among my crimes, that I return in a carriage from M. Brillon’s?

GOUT. Certainly; for, having been seated all the while, you cannot object the fatigue of the day, and cannot want therefore the relief of a carriage.

FRANKLIN. What then would you have me do with my carriage?

GOUT. Burn it if you choose; you would at least get heat out of it once in this way; or, if you dislike that proposal, here’s another for you; observe the poor peasants, who work in the vineyards and grounds about the villages of Passy, Auteuil, Chaillot, etc.; you may find every day among these deserving creatures, four or five old men and women, bent and perhaps crippled by weight of years, and too long and too great labor. After a most fatiguing day, these people have to trudge a mile or two to their smoky huts. Order your coachman to set them down. This is an act that will be good for your soul; and, at the same time, after your visit to the Brillons, if you return on foot, that will be good for your body.

FRANKLIN. Ah! how tiresome you are!

GOUT. Well, then, to my office; it should not be forgotten that I am your physician. There.

FRANKLIN. Ohhh! what a devil of a physician!

GOUT. How ungrateful you are to say so! Is it not I who, in the character of your physician, have saved you from the palsy, dropsy, and apoplexy? one or other of which would have done for you long ago, but for me.

FRANKLIN. I submit, and thank you for the past, but entreat the discontinuance of your visits for the future; for, in my mind, one had better die than be cured so dolefully. Permit me just to hint, that I have also not been unfriendly to you. I never feed physician or quack of any kind, to enter the list against you; if then you do not leave me to my repose, it may be said you are ungrateful too.

GOUT. I can scarcely acknowledge that as any objection. As to quacks, I despise them; they may kill you indeed, but cannot injure me. And, as to regular physicians, they are at last convinced that the gout, in such a subject as you are, is no disease, but a remedy; and wherefore cure a remedy?—but to our business,—there.

FRANKLIN. Oh! oh!—for Heaven’s sake leave me! and I promise faithfully never more to play at chess, but to take exercise daily, and live temperately.

GOUT. I know you too well. You promise fair; but, after a few months of good health, you will return to your old habits; your fine promises will be forgotten like the forms of the last year’s clouds. Let us then finish the account, and I will go. But I leave you with an assurance of visiting you again at a proper time and place; for my object is your good, and you are sensible now that I am your real friend.



Related books:

The Oxford Book of American Essays

The Art of Virtue

Hollywood Success: Luck or Skill? - 2006 Article by Leonard Mlodinow

The magic of Hollywood success—how can one account for it? Were the executives at Fox and Sony who gambled more than $300 million to create the hits “X-Men: The Last Stand” and “The Da Vinci Code” visionaries? Were those at Universal responsible for the box-office disaster “United 93” and their peers at Warner Bros. and Virtual Studios who pumped $160 million into the flop “Poseidon” just boneheads?

The 2006 summer blockbuster season is upon us, one of the two times each year (the other is Christmas) when a film studio’s hopes for black ink are decided by the gods of movie fortune—namely, you and me. Americans may not scurry with enthusiasm to vote for our presidents, but come summer, we do vote early and often for the films we love, to the tune of about $200 million each weekend. For the people who make the movies, it’s either champagne or Prozac as a river of green flows through Tinseltown, dragging careers with it, sometimes for a happy, wild ride, sometimes directly into a rock.

But are the rewards (and punishments) of the Hollywood game deserved, or does luck play a far more important role in box-office success (and failure) than people imagine?

We all understand that genius doesn’t guarantee success, but it’s seductive to assume that success must come from genius. As a former Hollywood scriptwriter, I understand the comfort in hiring by track record. Yet as a scientist who has taught the mathematics of randomness at Caltech, I also am aware that track records can deceive. That no one can know whether a film will hit or miss has been an uncomfortable suspicion in Hollywood at least since novelist and screenwriter William Goldman enunciated it in his classic 1983 book “Adventures in the Screen Trade.” If Goldman is right and a future film’s performance is unpredictable, then there is no way studio executives or producers, despite all their swagger, can have a better track record at choosing projects than an ape throwing darts at a dartboard.

That’s a bold statement, but these days it is hardly conjecture: With each passing year the unpredictability of film revenue is supported by more and more academic research.


Related book: The Drunkard's Walk: How Randomness Rules Our Lives

Saturday, February 21, 2009

Friday, February 20, 2009

Analysis of Berkshire Hathaway

The paragraphs below are from an article by Whitney Tilson in November of last year when people were worried about Berkshire's index puts. T2's full analysis of Berkshire is available HERE. As Mr. Tilson pointed out, the worries were overblown and Mr. Buffett didn't need to earn a real high return for them to end up profitable, even if the markets didn't recover in any dramatic fashion over the next 13.5 years. Since then, Buffett has been putting money to work, in senior position securities, at rates higher than those Tilson mentioned, in high quality companies such as Harley Davidson and Tiffany (among others). If anything, Berkshire's value has probably increased a bit since Tilson's article, unless, of course, you assume Buffett has lost his touch, which a big portion of sellers seems to think is the case. I tend to disagree and think that Buffett has gotten better. Economic times are tough, markets are volatile and it may be tough to keep a cool head. But what do you want to own coming out of this? Maybe a diversified business that is stacked with competitively advantaged businesses with good balance sheets to take advantage of weaker competitors, where the excess cash and float from all of the businesses are being reinvested by the man who is very likely the greatest investor of all time, at a valuation that may be the cheapest on a price to current value than it has ever been since Mr. Buffett took over in the 1960's? I think so, and I think this is one of those 20 punch card investments that Buffett has talked about. As I type, the Berkshire B shares are at $2,340 per share. There is actually a greater than 6% difference from what the A shares are and should be trading at in relation to the B shares, so there is some added pressure on the B's (divide T2's valuation of the A shares by 30 to get the equivalent value for the B's). I think this is a value that, although we can't predict what will happen over the short run, will prove to be one of the greatest risk vs. reward opportunities I will ever see. The question the investor needs to ask now is: Do I have the fortitude to be greedy when others are fearful?

At $77,500, Berkshire’s stock today is the cheapest, by far, we have ever seen it, going back at least a dozen years.

We estimate Berkshire’s valuation the same way Buffett does: we value the investment per share (cash, bonds and stocks) at market and then place a 12 multiple on the pre-tax operating profits of the company (for more details on this as well as our entire analysis of Berkshire, see our presentation, which is posted here). As of the end of last year, investments per share were $90,343 and our estimate of normalized pretax earnings was $5,500-$5,700/share, which resulted in an estimate of intrinsic value of $156,300-$158,700.

As of the end of the third quarter, investments per share had fallen to $86,000 due to declines in the prices of stocks Berkshire holds as well as Buffett investing tens of billions of cash in a wide range of operating businesses. In light of the severe market decline in October and so far in November plus additional investments Buffett has made, we estimate that investments per share might have fallen to as low as $76,000.

As for Berkshire’s earnings, they are obviously impacted by the weak economy, but this is offset by the many new businesses Buffett has purchased. Over time, the many investments and acquisitions Buffett’s made this year will lead to much higher earnings, but for the next 12 months, to be conservative, let’s assume that pretax earnings are $5,000/share (assuming the severe recession continues and a normal super cat year). This results in an estimate of intrinsic value of $136,000, 76% above today’s level.
Another way to think about Berkshire’s value is to consider that Berkshire’s share price today barely exceeds investments. Thus, today one can own the collection of fabulous businesses that Buffett has acquired over the years for less (pretty much for free).

In this environment, it’s not surprising to us that the stocks of companies with shaky balance sheets, poor business models and/or weak competitive positions are getting clobbered, but Berkshire’s freefall in the past few weeks is certifiably crazy – and a buying opportunity that will long be remembered.

Tuesday, February 17, 2009

MCM 2008 Annual Report


Previous reports available HERE
Related Book: Speculative Contagion: An Antidote for Speculative Epidemics

The No-Stats All-Star - by Michael Lewis

This story reminds me of the quote, "There's no limit to what a man can do or where he can go if he doesn't mind who gets the credit."
Battier’s game is a weird combination of obvious weaknesses and nearly invisible strengths. When he is on the court, his teammates get better, often a lot better, and his opponents get worse — often a lot worse. He may not grab huge numbers of rebounds, but he has an uncanny ability to improve his teammates’ rebounding. He doesn’t shoot much, but when he does, he takes only the most efficient shots. He also has a knack for getting the ball to teammates who are in a position to do the same, and he commits few turnovers. On defense, although he routinely guards the N.B.A.’s most prolific scorers, he significantly ­reduces their shooting percentages. At the same time he somehow improves the defensive efficiency of his teammates — probably, Morey surmises, by helping them out in all sorts of subtle ways. “I call him Lego,” Morey says. “When he’s on the court, all the pieces start to fit together. And everything that leads to winning that you can get to through intellect instead of innate ability, Shane excels in. I’ll bet he’s in the hundredth percentile of every category.”

There are other things Morey has noticed too, but declines to discuss as there is right now in pro basketball real value to new information, and the Rockets feel they have some. What he will say, however, is that the big challenge on any basketball court is to measure the right things. The five players on any basketball team are far more than the sum of their parts; the Rockets devote a lot of energy to untangling subtle interactions among the team’s elements. To get at this they need something that basketball hasn’t historically supplied: meaningful statistics. For most of its history basketball has measured not so much what is important as what is easy to measure — points, rebounds, assists, steals, blocked shots — and these measurements have warped perceptions of the game. (“Someone created the box score,” Morey says, “and he should be shot.”) How many points a player scores, for example, is no true indication of how much he has helped his team. Another example: if you want to know a player’s value as a ­rebounder, you need to know not whether he got a rebound but the likelihood of the team getting the rebound when a missed shot enters that player’s zone.

There is a tension, peculiar to basketball, between the interests of the team and the interests of the individual. The game continually tempts the people who play it to do things that are not in the interest of the group. On the baseball field, it would be hard for a player to sacrifice his team’s interest for his own. Baseball is an individual sport masquerading as a team one: by doing what’s best for himself, the player nearly always also does what is best for his team. “There is no way to selfishly get across home plate,” as Morey puts it. “If instead of there being a lineup, I could muscle my way to the plate and hit every single time and damage the efficiency of the team — that would be the analogy. Manny Ramirez can’t take at-bats away from David Ortiz. We had a point guard in Boston who refused to pass the ball to a certain guy.” In football the coach has so much control over who gets the ball that selfishness winds up being self-defeating. The players most famous for being selfish — the Dallas Cowboys’ wide receiver Terrell Owens, for instance — are usually not so much selfish as attention seeking. Their sins tend to occur off the field.

It is in basketball where the problems are most likely to be in the game — where the player, in his play, faces choices between maximizing his own perceived self-interest and winning. The choices are sufficiently complex that there is a fair chance he doesn’t fully grasp that he is making them.

Knowing the odds, Battier can pursue an inherently uncertain strategy with total certainty. He can devote himself to a process and disregard the outcome of any given encounter. This is critical because in basketball, as in everything else, luck plays a role, and Battier cannot afford to let it distract him. Only once during the Lakers game did we glimpse a clean, satisfying comparison of the efficient strategy and the inefficient one — that is, an outcome that reflected the odds. Ten feet from the hoop, Bryant got the ball with his back to the basket; with Battier pressing against him, he fell back and missed a 12-foot shot off the front of the rim. Moments earlier, with Battier reclining in the deep soft chair that masquerades as an N.B.A. bench, his teammate Brent Barry found himself in an analogous position. Bryant leaned into Barry, hit a six-foot shot and drew a foul. But this was the exception; normally you don’t get perfect comparisons. You couldn’t see the odds shifting subtly away from the Lakers and toward the Rockets as Bryant was forced from 6 feet out to 12 feet from the basket, or when he had Battier’s hand in his eyes. All you saw were the statistics on the board, and as the seconds ticked off to halftime, the game tied 54-54, Bryant led all scorers with 16 points.

But he required 20 possessions to get them. And he had started moaning to the referees. Bryant is one of the great jawboners in the history of the N.B.A. A major-league baseball player once showed me a slow-motion replay of the Yankees’ third baseman Alex Rodriguez in the batter’s box. Glancing back to see where the catcher has set up is not strictly against baseball’s rules, but it violates the code. A hitter who does it is likely to find the next pitch aimed in the general direction of his eyes. A-Rod, the best hitter in baseball, mastered the art of glancing back by moving not his head, but his eyes, at just the right time. It was like watching a billionaire find some trivial and dubious deduction to take on his tax returns. Why bother? I thought, and then realized: this is the instinct that separates A-Rod from mere stars. Kobe Bryant has the same instinct. Tonight Bryant complained that Battier was grabbing his jersey, Battier was pushing when no one was looking, Battier was committing crimes against humanity. Just before the half ended, Battier took a referee aside and said: “You and I both know Kobe does this all the time. I’m playing him honest. Don’t fall for his stuff.” Moments later, after failing to get a call, Bryant hurled the ball, screamed at the ref and was whistled for a technical foul.

In 1996 a young writer for The Basketball Times named Dan Wetzel thought it might be neat to move into the life of a star high-school basketball ­player and watch up close as big-time basketball colleges recruited him. He picked Shane Battier, and then spent five months trailing him, with growing incredulity. “I’d covered high-school basketball for eight years and talked to hundreds and hundreds and hundreds of kids — really every single prominent high-school basketball player in the country,” Wetzel says. “There’s this public perception that they’re all thugs. But they aren’t. A lot of them are really good guys, and some of them are very, very bright. Kobe’s very bright. LeBron’s very bright. But there’s absolutely never been anything like Shane Battier.”

Wetzel watched this kid, inundated with offers of every kind, take charge of an unprincipled process. Battier narrowed his choices to six schools — Kentucky, Kansas, North Carolina, Duke, Michigan and Michigan State — and told everyone else, politely, to leave him be. He then set out to minimize the degree to which the chosen schools could interfere with his studies; he had a 3.96 G.P.A. and was poised to claim Detroit Country Day School’s headmaster’s cup for best all-around student. He granted each head coach a weekly 15-minute window in which to phone him. These men happened to be among the most famous basketball coaches in the world and the most persistent recruiters, but Battier granted no exceptions. When the Kentucky coach Rick Pitino, who had just won a national championship, tried to call Battier outside his assigned time, Battier simply removed Kentucky from his list. “What 17-year-old has the stones to do that?” Wetzel asks. “To just cut off Rick Pitino because he calls outside his window?” Wetzel answers his own question: “It wasn’t like, ‘This is a really interesting 17-year-old.’ It was like, ‘This isn’t real.’ ”


Related book: Moneyball: The Art of Winning an Unfair Game-

Friday, February 13, 2009

GMO - Jeremy Grantham's 4Q 2008 Letter (Parts 1 & 2)

Previously, only Part 1 was posted.
The Year of the Value Trap

The value problems of the last two years were particularly bad because of the outperformance that value stocks had between 2002 and 2007. They won for five years in a row, so that by mid 2007 the value/growth spread was about as unfavorable as possible for value stocks in the U.S. (see Exhibit 1). (We recognize that some value investors disagreed with this data when it was first presented. We were, and still are, puzzled by how they arrived at their more positive conclusion.)

To put a measure on how awful the value trap was during this time, please see the Fall 2007 edition of the Outstanding Investor Digest. This publication concentrates on a dozen or so of the top value investors and is readable, interesting, and chock-full of insight. However, that particular issue is a heartbreaker as one after another of these superior investors put forward the case that – down 30% to 50% – AIG, Lehman, Wachovia, Fannie Mae, etc., were ridiculously underpriced, and represented enormous long-term franchise value that the nervous market was missing.

Michael Farrell - Annaly: Just Save, Baby, Just Save

As we sit on the precipice of the greatest fiscal stimulus package in our nation’s history, the question we are asked most often during our discussions with market participants is “When will it end?” Well, we can’t tell you the exact date, but I believe that a precursor will be the stabilization of mortgage cash flows. I can say that with certainty because from where we sit the current instability in the economy began showing its teeth in the mortgage market in 2002 and it will ultimately end once those cash flows stabilize again. When this occurs—at some uncertain future date—property valuations will have found a bottom and new run rates in GDP will have been established.

The sooner this happens, the better; but in the interim, we as a nation will be faced with policies designed to maintain the consumption-driven force of our domestic economy. My view is that this is what got us into this problem in the first place, and it runs counter to what Americans are now doing as rational economic beings—we are reducing consumption and increasing savings. The following is a construct of Newton’s principles. For every action, there is an equal and opposite reaction. We are witnessing the reaction of America’s primary Gross Domestic Product component, its consumers, as they retrench and repair their own balance sheets.
We should set a national target personal savings rate of 15% to provide the balance required to properly value and control our domestic economy. The increase to 15% amounts to a diversion of about $1.2 trillion in personal savings away from consumption, or a little more than the size of the proposed stimulus package. Our national security interests are at stake here, not simply the price of our standard of living. We all sense that higher taxes are coming at the Federal and municipal levels. Entitlements are going to be renegotiated. Social Security will be reformatted to reflect the fact that we are living longer and the pool of payers is shrinking. Medicare/Medicaid and healthcare will be restructured to a socialist model. But, we still need to pay for it. At this point in the economic cycle, savers are the key to survival, not consumers. With this in place, the America of the immediate future will look, at best, a lot like the America of the 1950’s. If we truly think that there is a short term solution via consumption then we deserve our fate. The long term view and solutions are much harder to take in the short run, but if Americans are incentivized to save their stimulus checks rather than spend them, it would help provide structurally sustainable fiscal health in the long run. This would position the country to win the economic war rather than the current battle.

The answer is that we need to swallow the full tablespoon of medicine or, to paraphrase Al Davis, the legendary owner of the Oakland Raiders, “Just save, baby.”


Related book:

The Richest Man in Babylon (also available in an Audio Book)

Wednesday, February 11, 2009

How We Can Restore Confidence - By Charles T. Munger

Our situation is dire. Moderate booms and busts are inevitable in free-market capitalism. But a boom-bust cycle as gross as the one that caused our present misery is dangerous, and recurrences should be prevented. The country is understandably depressed -- mired in issues involving fiscal stimulus, which is needed, and improvements in bank strength. A key question: Should we opt for even more pain now to gain a better future? For instance, should we create new controls to stamp out much sin and folly and thus dampen future booms? The answer is yes.

Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct. And only when there is strong public revulsion, such as exists today, can legislators minimize the influence of powerful special interests enough to bring about needed revisions in law.

Many contributors to our over-the-top boom, which led to the gross bust, are known. They include insufficient controls over morality and prudence in banks and investment banks; undesirable conduct among investment banks; greatly expanded financial leverage, aided by direct or implied use of government credit; and extreme excess, sometimes amounting to fraud, in the promotion of consumer credit. Unsound accounting was widespread.

There was also great excess in highly leveraged speculation of all kinds. Perhaps real estate speculation did the most damage. But the new trading in derivative contracts involving corporate bonds took the prize. This system, in which completely unrelated entities bet trillions with virtually no regulation, created two things: a gambling facility that mimicked the 1920s "bucket shops" wherein bookie-customer types could bet on security prices, instead of horse races, with almost no one owning any securities, and, second, a large group of entities that had an intense desire that certain companies should fail. Croupier types pushed this system, assisted by academics who should have known better. Unfortunately, they convinced regulators that denizens of our financial system would use the new speculative opportunities without causing more harm than benefit.

Considering the huge profit potential of these activities, it may seem unlikely that any important opposition to reform would come from parties other than conventional, moneyed special interests. But many in academia, too, will resist. It is important that reform plans mix moral and accounting concepts with traditional economic concepts. Many economists take fierce pride in opposing that sort of mixed reasoning. But what these economists like to think about is functionally intertwined, in complex ways, with what they don't like to think about. Those who resist the wider thinking are acting as engineers would if they rounded pi from 3.14 to an even 3 to simplify their calculations. The result is a kind of willful ignorance that fails to understand much that is important.

Moreover, rationality in the current situation requires even more stretch in economic thinking. Public deliberations should include not only private morality and accounting issues but also issues of public morality, particularly with regard to taxation. The United States has long run large, concurrent trade and fiscal deficits while, to its own great advantage, issuing the main reserve currency of a deeply troubled and deeply interdependent world. That world now faces new risks from an expanding group of nations possessing nuclear weapons. And so the United States may now have a duty similar to the one that, in the danger that followed World War II, caused the Marshall Plan to be approved in a bipartisan consensus and rebuild a devastated Europe.

The consensus was grounded in Secretary of State George Marshall's concept of moral duty, supplemented by prudential considerations. The modern form of this duty would demand at least some increase in conventional taxes or the imposition of some new consumption taxes. In so doing, the needed and cheering economic message, "We will do what it takes," would get a corollary: "and without unacceptably devaluing our money." Surely the more complex message is more responsible, considering that, first, our practices of running twin deficits depend on drawing from reserves of trust that are not infinite and, second, the message of the corollary would not be widely believed unless it was accompanied by some new taxes.

Moreover, increasing taxes in some instances might easily gain bipartisan approval. Surely both political parties can now join in taxing the "carry" part of the compensation of hedge fund managers as if it was more constructively earned in, say, cab driving.

Much has been said and written recently about bipartisanship, and success in a bipartisan approach might provide great advantage here. Indeed, it is conceivable that, if legislation were adopted in a bipartisan way, instead of as a consequence of partisan hatred, the solutions that curbed excess and improved safeguards in our financial system could reduce national pain instead of increasing it. After the failure of so much that was assumed, the public needs a restoration of confidence. And the surest way to gain the confidence of others is to deserve the confidence of others, as Marshall did when he helped cause passage of some of the best legislation ever enacted.

Creating in a bipartisan manner a legislative package that covers many subjects will be difficult. As they work together in the coming weeks, officials might want to consider a precedent that helped establish our republic. The deliberative rules of the Constitutional Convention of 1787 worked wonders in fruitful compromise and eventually produced the U.S. Constitution. With no Marshall figure, trusted by all, amid today's legislators, perhaps the Founding Fathers can once more serve us.
Related books:

Monday, February 9, 2009

CNBC: Predicting Crisis: Dr. Doom & the Black Swan

Nouriel Roubini and Nassim Taleb on CNBC:
Related books:
Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (Also available in an Audio Book) - Note: Nassim Taleb updated this book last year. I belive it is about 1/3 longer than the first edition.

Amazon's Kindle 2 Slims Down, Adds Audio

New York – A little more than a year after the Kindle made its debut, Amazon announced a new, updated version of its popular e-book reader Monday with a big endorsement from Stephen King.

Amazon founder Jeff Bezos demonstrated the features of the new device, called Kindle 2, at a crowded press event at the Morgan Library and Museum in New York. He stressed the need for the Kindle to "disappear" so the reader can focus on the text. Bezos himself then disappeared, welcoming novelist Stephen King to the stage to give his take and announce a Kindle-only novella he wrote specifically for Amazon.

As predicted in leaked photos, the new Kindle 2 has a much slimmer profile than the original (.36” thick compared to the first version's 0.7" thick), is slightly lighter (10.2 ounces versus the original 10.3 ounces), has curved edges, and includes a sleeker, unified keyboard with a 5-way joystick instead of the original device's scroll wheel. And the navigation buttons have been pushed down for tighter control (and to avoid the accidental page-turning that many users complained about). Kindle 2 has a 25 percent longer battery life, Bezos claimed, and contains 2GB of memory that can hold more than 1,500 books.

There is also a new iPod-like metal back plate and a set of stereo speakers along the bottom, which enable a new feature: The Kindle 2 can convert any text to audio, so it can "read" books to you in a somewhat robotic, artificial-sounding voice. (King jokingly called this a "GPS voice").

Another major update is a new Whispersync service which makes it easier for original Kindle owners to transfer e-books they've already purchased to the new device. Whispersync will eventually work on a number of mobile devices as well, enabling Kindle owners to read their books on other devices.

The Kindle's screen has been improved, too: The E-Ink technology, already easier on the eyes than a computer screen or standard LCD screen, has been updated to 16 shades of gray, up from the current model's 4 levels of gray. It also turns pages 20 percent faster on average than the previous model, Bezos said.
Kindle 2

Bill Gates' Q&A with Chris Anderson: Video unveiled


Friday, February 6, 2009

WIRED Interview with Barry Schwartz

LONG BEACH, California -- Psychologist Barry Schwartz delivers the final presentation of TED 2009 on Saturday. spoke to Schwartz about practical wisdom, moral skill without moral will, and the roles of hope and virtue.

Wired: You call practical wisdom the "master virtue." What is practical wisdom and why is it important?

Barry Schwartz: Very central to Aristotle was the notion that to do the right thing, and ultimately to be happy, required that you be a person with the right character -- courage, honesty, perseverance, and so on....

The problem was that having these virtues wasn't enough, because, how courageous should you be and when should you be courageous? The circumstances we face from day to day are varied and multiple, so you can’t be formulaic about it. You need to use your judgment. And the virtue that is the judgment virtue is what he called "practical wisdom." It's knowing when and how to display the other virtues. It's knowing how to choose when two virtues conflict.

Wired: It sounds like you're talking about the ability to reason.

BS: Well it’s a particular kind of reason. Practical wisdom is what's called for in situations that have a moral dimension to them. There are dozens of decisions we make every day that call upon us to be wise in our interactions with other people.... They're usually too small for us to even appreciate that there's a moral dilemma to them. And that's the kind of thing we think wisdom applies to.

The way Ken and I talk about wisdom, it's composed of two different components.

One is what we call moral skill, which is the ability to figure out what's called for in a given situation. It's kind of analogous to what people call emotional intelligence –- the ability to read people, understand where they're coming from, what they're aspiring to. The second component is moral will, which is the desire to do the right thing. If you have lots of moral skill but not the will do to the right thing, then you're a [Bernard] Madoff because you use all of the moral skill to manipulate people to serve your ends. It's Machiavellian if it's de-coupled from the desire to do the right thing.

Wired: You've said in the past that we've lost practical wisdom. How and when did we lose it?

BS: I think it's a gradual process. We've lost it in part because we don't appreciate how important it is and what it takes to develop it.

It takes two things to develop wisdom.... You need to have autonomy, and you need to try things [and] see them fail and get feedback and slowly over time develop a kind of sensitivity to what each situation demands. If you put people in a situation where they are rigidly following rules, they will never have the opportunity to develop this judgment. Rules eliminate the need for judgment. And one of the things we have increasingly done in American society -- partly I think because we're worried about somebody suing us -- is we develop more and more rules and take individual discretion increasingly out of the hands of the people who actually provide the service [in a company or organization].

Wired: How do you nurture people to do the right thing?

BS: I think the first step toward achieving these things is appreciating that the tools we currently use are not sufficient.... The step after that is to identify and acknowledge the existence of moral exemplars – if you like, moral heroes -- that the people you're training can aspire to emulate. And they don't have to be people who do extraordinary things. There are people who do small things that count as moral heroes. And then giving the people you're training the room both to improvise and to have room in their lives for wanting to do the right thing and not just the profitable thing.


Related books:

The Paradox of Choice: Why More Is Less

Practical Intelligence in Everyday Life

The Theory of Moral Sentiments

The Moral Consequences of Economic Growth

The Autobiography of Benjamin Franklin

Related previous post:

Ben Franklin's 13 Virtues

Related links:


Barry Schwartz on practical wisdom

Bill Gates' TED Talk: How I'm trying to change the world now

Thursday, February 5, 2009

Unfinished business

Charles Darwin’s ideas have spread widely, but his revolution is not yet complete

THE miracles of nature are everywhere: on landing, a beetle folds its wings like an origami master; a lotus leaf sheds muddy water as if it were quicksilver; a spider spins a web to entrap her prey, but somehow evades entrapment herself. Since the beginning of time, people who have thought about such things have seen these marvels as examples of the wisdom of God; even as evidence for his existence. But 200 years ago, on February 12th 1809, a man was born who would challenge all that. The book that issued the challenge, published half a century later, in 1859, offered a radical new view of the living world and, most radical of all, of humanity’s origins. The man was Charles Robert Darwin. The book was “On the Origin of Species”. And the challenge was the theory of evolution by natural selection.

Since Darwin’s birth, the natural world has changed beyond recognition. Then, the modern theory of atoms was scarcely six years old and the Earth was thought to be 6,000. There was no inkling of the size of the universe beyond the Milky Way, and radioactivity, relativity and quantum theory were unimaginable. Yet of all the discoveries of 19th- and early 20th-century science—invisible atoms, infinite space, the inconstancy of time and the mutability of matter—only evolution has failed to find general acceptance outside the scientific world. Few laymen would claim they did not believe Einstein. Yet many seem proud not to believe Darwin. Even for those who do accept his line of thought his ideas often seem as difficult today as they were 150 years ago.

The origin of the Origin

The idea of evolution by natural selection is not hard to grasp. It just requires connecting some uncontentious propositions. These are that organisms vary from one another, even within a species, and that new variation can arise from time to time; that some of this variation is passed from parent to offspring; and that more individuals are born than can exist in the available space (or be sustained by the available resources). The consequence is what Darwin described in his book as a “struggle for existence”. The weakest are eliminated in this struggle. The fit survive. The survivors pass on their traits to their offspring. Over enough time, this differential transmission of characters will lead to the formation of a new species.

Darwin’s theory explained why species were so well adapted to their environment and how new species would form. It suggested that all living things were related, from the beetle to the lotus, and that everything descended ultimately from a single common ancestor. Evolution thus removed the need for divine explanations of diversity and, along with evidence emerging at that time of the extreme age of the Earth, it further suggested that the wider universe might also owe nothing to divine intervention and everything to natural laws. Darwin understood all of this and was greatly troubled.

That trouble continues today. In the United States a Gallup poll conducted last year found that only 14% of people agreed with the proposition that “humans developed over millions of years”, up from 9% in 1982. Acceptance of evolution varies around the world, with the most ardent believers being in Iceland, Denmark and Sweden (see chart). In general, as you might expect, a country’s belief in evolution is inversely correlated with its belief in God. But there is an interesting twist.

Gregory Paul, an independent researcher on evolution, and Phil Zuckerman, a sociologist at Pitzer College in California, have argued controversially that a belief in God is inversely correlated with the level of what might be described as the intensity of the struggle for existence. In countries where food is plentiful, health care is universal and housing is accessible, people believe less in God than in those countries where their lives are insecure. A belief in God, and rejection of evolution, they suggest, is most valuable in those societies that are most subject to Darwinian pressures.

Making science work

Be that as it may, many aspects of modern science could not work without accepting evolution. Darwin’s ideas touch every corner of biology and medicine. They have also had an impact farther afield, in areas from art to politics. And their impact has been practical as well as theoretical. Both software engineers and drug developers, for example, often make use of evolutionary thinking when designing their products.

Economics, too, may be helped by Darwin. Ideas about “rational” economic man are being overturned by new ones from a discipline called behavioural economics. Rather than assuming that individuals faced with economic decisions will comport themselves in what “classical” economists regard as a rational manner—ie, to maximise their future wealth—behavioural economics tries to study how real people actually behave.

What is surprising is the degree to which human beings are not rational, and how the reasons for this are likely to involve Darwinian explanations. Take, for example, a phenomenon called the endowment effect, which is the tendency most people have to value objects they already own more highly than similar ones they have never owned—and, consequently, to be more reluctant to trade them than a classical economist would predict.

Because this effect has been observed in three primate species, most recently in a study of chimpanzees, it suggests this effect has evolutionary roots. Its strength seems to relate to the evolutionary salience of the item in question. People may be reluctant to trade goods related to food and mating because in the recent evolutionary past it meant parting with a known object in exchange for an uncertain proposition.

Another example of economic behaviour that may have deep evolutionary roots is the “herd” mentality that contributes to financial bubbles. In the past, copying the neighbours would have been helpful—in order to avoid danger or to find food. In today’s financial systems, however, it can create instability. The instinct to follow the herd can be rationalised as rational, so to speak, since everybody benefits in the short term by forcing the price up. But it does not look so rational when the instability is exposed by an external shock and the market crashes. In fact, at least part of what seems to be going on is that everyone instinctively feels compelled to copy the others, rather than making an independent assessment of the situation.

Whether the mystery is why people are so averse to risk, unable to estimate the time needed for a given task, or give different answers to the same question depending on how it is framed, there is a fair chance that the explanation will, at some point, involve evolution. To understand human behaviour properly, the world needs Darwin. Some have said it is the best idea that anyone ever had. If it isn’t, it certainly comes close.

Despite so much evidence, evolution remains difficult to accept because it implies everything living is largely accidental. Stephen Jay Gould, an American evolutionary biologist, who died in 2002, argued that misunderstandings about Darwinism were rife not because the theory is difficult to understand but because people actively avoid trying to understand it. He thought a misunderstanding about progress was the problem.


Related previous post:

Why we are, as we are

Related books:

The Autobiography of Charles Darwin

The Origin Of Species

The Voyage of the Beagle

The Selfish Gene

Mean Genes
Darwin quote from Favorite Quotes post (taken from his autobiography):
"I have been speculating...what makes a man a discoverer of undiscovered things, and a most perplexing problem it is. Many men who are very clever, -- much cleverer than discoverers -- never originate anything. As far as I can conjecture, the art consists in habitually searching for causes or meaning of everything which occurs. This implies sharp observation and requires as much knowledge as possible of the subject investigated." -Charles Darwin

Pershing Square Presentation


Wednesday, February 4, 2009

Fortune: Loomis, Burke - Buffett's metric says it's time to buy

Looks like Carol Loomis, Doris Burke and me (and Will, who emailed me about this months ago) are all on the same page.
According to investing guru Warren Buffett, U.S. stocks are a logical investment when their total market value equals 70% to 80% of Gross National Product.

Is it time to buy U.S. stocks?

According to both this 85-year chart and famed investor Warren Buffett, it just might be. The point of the chart is that there should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy - its GNP.

Fortune first ran a version of this chart in late 2001 (see "Warren Buffett on the stock market"). Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks.

But he visualized a moment when purchases might make sense, saying, "If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you."

Well, that's where stocks were in late January, when the ratio was 75%. Nothing about that reversion to sanity surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham's statement about the stock market: "In the short run it's a voting machine, but in the long run it's a weighing machine."

Not just liking the chart's message in theory, Buffett also put himself on record in an Oct. 17 New York Times op-ed piece, saying that he was personally buying U.S. stocks after a long period of owning nothing (outside of Berkshire Hathaway (BRKB) stock) but U.S. government bonds.

He said that if prices kept falling, he expected to soon have 100% of his net worth in U.S. equities. Prices did keep falling - the Dow Jones industrials have dropped by about 10% since Oct. 17 - so presumably Buffett kept buying. Alas for all curious investors, he isn't saying what he bought.
Related previous posts:

Buy American. I Am. - By WARREN E. BUFFETT

Warren Buffett's 4 Market Call Articles

WCAM: How Inflation Became the Good Guy

Inflation has been an all-purpose bogeyman since the 1970s, but a small amount of inflation comes with a healthy, growing economy. The Federal Reserve focuses on managing inflation, not preventing it. We have written often that we feel the government measures inflation incorrectly, since the Consumer Price Index undervalues food, healthcare and energy costs. As a result, excessive inflation builds for a while before the government acknowledges it, and comes as a surprise, despite our constant measurement and analysis.

But the consumer price index is only one measure of inflation. Another is the Producer Price Index (PPI), which measures inflation faced by people who buy raw materials to create other products. Watching the constant rise of producer prices over the past years, as consumer prices appeared stable, a thoughtful observer sensed that “something’s gotta give.” Add a significant credit crisis, a sudden liquidity crisis, a Fed Chairman who dreads the Great Depression’s deflation, and the table is set for significant inflation, and the possibility of hyperinflation.

The current economic crisis raises the specter of both deflation and hyperinflation for many economists and journalists, and “specter” is the operative word here. Studying deflation and hyperinflation is a little bit like studying Bigfoot and the Loch Ness monster. Deflation and hyperinflation are real, but there is as much lore as evidence in the popular press and on the Internet. In times of crisis, one struggles to separate political agendas and fear mongering from analysis.

With our currency likely to be dropping in value and our interest rates likely to be moving up (they certainly cannot go down much farther), what should one own?

Real assets and companies that can withstand and benefit from inflation over the long term are good options. Examples include companies with popular, everyday products, like Johnson & Johnson (NYSE: JNJ), Cadbury (NYSE: CBY), Clorox (NYSE: CLX), Kimberly Clark (NYSE: KMB), and Molson Coors (NYSE: TAP).

Another opportunity might lie with companies like Automatic Data Processing (NasdaqGS: ADP), which processes payrolls and earns float on the overnight deposits. As interest rates rise, so will ADP’s profits. Payroll processors might experience a dip in volume as layoffs and bankruptcies spread, so investors must consider that risk. Other ports in an inflationary storm usually include real assets like oil, coal, steel, lumber, copper, and gold.