Our friends at BeyondProxy and The Manual of Ideas were kind enough to post an excerpt from the Boyles Q1 Letter, which is linked to below.
Tuesday, April 29, 2014
In this age of zero privacy, Mark Leonard has managed to maintain a practically unthinkable level of anonymity for just about any individual—let alone an IT executive who runs one of Canada’s most dynamic, fastest-growing and most acquisitive software companies, and who has been compared favourably with Warren Buffett and Prem Watsa. So it’s no surprise that Leonard would probably prefer not to be the subject of a profile in this magazine. For that matter, he would prefer not to be the subject of a profile in any magazine. Or newspaper. Or trade publication. Or television show (you know, if there were a television show devoted to profiling Canadian business leaders). No, the founder, president and chairman of Constellation Software Inc.—a Toronto-based, publicly traded software company with a $5-billion-plus market cap and one of the best-performing stocks on the TSX—would prefer not to be profiled at all. And so far, in the nearly 20-year history of Constellation, he’s done a pretty good job of staying out of the spotlight.
[H/T Santangel’s Review]
Link to interview: Warren Buffett: We took a stand on Coke's pay package
FORTUNE -- Last week, Warren Buffett declined to vote against a controversial stock option plan for Coca-Cola's (KO) top executives that he thought was excessive. That has unleashed a wave of criticism against the legendary investor and CEO of insurance conglomerate Berkshire Hathaway (BRKA), typically a media darling. New York Times columnist Joe Nocera called Buffett a coward. Shortly after the Coke vote, Buffett sat down with Fortune to defend himself.
Despite the criticism, Buffett says he believes he took a forceful stand against the Coke pay package. What's more, he says that he has little power to stop companies from handing out excessive pay. That's a big change from a few years ago, when Buffett wrote that large shareholders like himself were the only ones who could turn back runaway executive compensation within corporate America. Apparently, Buffett and others like him are outmatched as well.
This book has long been on my list to read, but unfortunately it had only been published in Portuguese. Last week an English version was released and you can now find it on Amazon. (Kindle version only). What follows is a summary of the book and some key takeaways.
Related book, which I believe serves as a model for what 3G does: Double Your Profits: In Six Months or Less
Link to video: Cosmos: A Spacetime Odyssey: Sisters of the Sun
Monday, April 28, 2014
Link to: Steve Romick's Q1 Commentary
Despite some modest retrenchment in quantitative easing, the world remains awash in liquidity. We wish we could tell you how this all ends but it’s beyond us. What we do know is that just because really smart people design something to happen doesn’t mean it will. Central bankers say they have everything under control, but that isn’t helping us sleep at night.
We feel a little out of whack in today’s investment environment. We’d like to think it’s due to central bank policies, but maybe not. We do know that: junk bond yields are close to an all-time low, as is the benchmark risk-free rate and covenant-lite loans are at a record high. The once-dicey sovereign debt of both Spain and Italy trades just 50 bps above comparable 10-year U.S. Treasuries and is apparently not so risky anymore. And, we can only wonder what buyers of Mexico’s $1.66 billion, 100-year sterling bond at a lowly yield of 5.75% were thinking. Equally remarkable is how few companies are trading at low multiples and even fewer companies are trading at steep declines from their highs – as the following two charts depict.
Suffice to say we aren’t seeing much in the way of fat pitches today, so we are comfortable just letting someone else swing at the junk that whizzes past us. We can, however, speak to what we think we do well – patiently wait for opportunity to invest in good assets at reasonable prices. This doesn’t mean we’re napping in the dugout. We have selectively entered the game, recently taking advantage of our broad mandate, as illustrated by the initiation of a handful of new positions, largely in emerging markets and commodity sensitive businesses. We will communicate more about these when we are no longer active in the market.
Link to: The Future is Now
While the evidence may be alarming to some, make no mistake: The median price/revenue multiple for S&P 500 constituents is now significantly higher than at the 2000 market peak. The average price/revenue multiple across S&P 500 constituents is now above every point in that bubble except the first and third quarters of 2000. Only the capitalization-weighted price/revenue multiple – presently at about 1.7 – is materially below the price/revenue multiple of 2.2 reached at the 2000 peak. That’s largely because S&P 500 market capitalization was dominated by high price/revenue technology stocks in 2000. [Geek's Note: as a result, if one chooses a universe of stocks by first sorting by market capitalization, one will probably find that price/revenue multiples of those stocks are lower today than in 2000]. Regardless, the historical norm for the capitalization-weighted S&P 500 price/revenue ratio is only about 0.80, less than half of present levels. The fact is that unless current record-high profit margins turn out to be permanent, against all historical experience to the contrary, the overvaluation of the broad equity market is equal or more extreme today than it was at the 2000 bubble peak.
Investors often forget that smaller stocks struggled during the final years of the bubble as investors clamored for glamour. Again, the broad stock market was much more reasonably valued in 2000 than it is today, as extreme valuations were skewed among the largest of the large caps. Not anymore. The Federal Reserve has stomped on the gas pedal for years, inadvertently taking price/earnings ratios at face value, while attending to “equity risk premium” models that have a demonstrably poor relationship with subsequent returns. As a result, the Fed has produced what is now the most generalized equity valuation bubble that investors are likely to observe in their lifetimes.
Friday, April 25, 2014
Link to video: Marks: `Public Money' Supporting Risky Investments
Related Memo: Dare to Be Great II
................April 24 (Bloomberg) -- Howard Marks, chairman of Oaktree Capital Group LLC, talks about investment strategy, risks, and financial markets. Marks speaks with Stephanie Ruhle and Erik Schatzker on Bloomberg Television's "Market Makers."
Related Memo: Dare to Be Great II
A long and comprehensive interview with one of the few macro guys I pay attention to. As he described this interview on his blog:
For anyone who is interested in understanding my views on the global economic crisis, this is the video I would recommend watching, if I could only recommend one. In it, I am able to address almost all of the ideas I have tried to convey through my books and speeches over the past ten years.
I just recently watched his 2nd quarter Macro Watch videos, which I thought were very good (see the bottom of this post for a link and coupon code to the videos). I also recommend his last book, The New Depression.
For those that are interested, Richard was kind enough to offer readers of this blog a 50% discount to his video newsletter, Macro Watch, using the coupon code 'valueinvestingworld', which I think should still be valid. While still an expensive service, the discount knocks the first year price from $500 down to $250. When you sign up (using PayPal), you enter into a recurring payment, so if you decide you don't want to keep the subscription after the first year, you can just cancel the service before your first year ends and not be charged any further.
Links to videos:
Buffett: Boards don't say no on CEO pay
Buffett: The stock market isn't rigged
Buffett laughs at the 'persecuted' 1%
Buffett unsure about minimum wage hike
Behind the Billions: 8 Things You Never Knew About Warren Buffett
Buffett Bullish on America Despite Middle Class Decline
Buffett: Boards don't say no on CEO pay
Buffett: The stock market isn't rigged
Buffett laughs at the 'persecuted' 1%
Buffett unsure about minimum wage hike
Behind the Billions: 8 Things You Never Knew About Warren Buffett
Buffett Bullish on America Despite Middle Class Decline
Link to article: The Untold Story Of Larry Page's Incredible Comeback
By August 2001, Schmidt had fully extricated himself from his responsibilities at Novell. He became Google’s CEO — so-called adult supervision for Page and his co-founder, Brin.And for a long time, Larry Page was very unhappy.Everyone knows the Steve Jobs story — how he was fired from the company he founded — Apple — only to return from exile decades later to save the business.What’s less-well understood is that Apple’s board and investors were absolutely right to fire Jobs. Early in his career, he was petulant, mean, and destructive. Only by leaving Apple, humbling himself, and finding a second success (with Pixar) was he able to mature into the leader who would return to Apple and build it into the world’s most-valuable company.Larry Page is the Steve Jobs of Google.Like Jobs, Page has a co-founder, Sergey Brin, but Page has always been his company’s true visionary and driving force.And just as Apple’s investors threw Jobs out of his company, Google’s investors ignored Page’s wishes and forced him to hire a CEO to be adult supervision.Both then underwent a long period in the wilderness. Steve Jobs’ banishment was more severe, but Page also spent years at a remove from the day-to-day world of Google.As with Jobs, it was only through this long exile that Page was able to mature into a self-awareness of his strengths and weaknesses.Then, like Jobs, Page came back with wild ambitions and a new resolve.
Thursday, April 24, 2014
I've seen a number of people, many who consider Buffett a hero and are not normally so quick to jump to conclusions when he says something, express disappointment over some of the comments Mr. Buffett has made about the Coca-Cola compensation plan, especially comments such as: "It's kind of un-American to vote no at a Coke meeting."
I'm going to let it set in a little longer, but I must admit, I'm a bit surprised. It's kind of hard to reconcile talking about excessive executive compensation for so long and admitting you thought Coke's plan was excessive, and then not vote against it. Even though he abstained from voting and came out and said it was excessive, it's still an interesting thing to do. But maybe he's also trying to be political in order to get Coke to alter the plan a bit, as it seems they might have a little discretion on the timing of the option awards. If the person who loves you most tells the world how much he loves you, but also says he's not a big fan of some of your actions, maybe it's a more effective way to ignite change in those actions. I don't know.
Another big issue revolves around the CNBC appearance, in this exchange with Becky Quick:
BECKY: Your math, does it match up with David Winters who is— is the activist who's been very vocal about this. By his math— he thinks it would be something like— a dilution of 16 percent to— existing shareholders— that are there. And—and Muhtar Kent has up from the company and he thinks it's more like 1 percent of—
BUFFETT: Well, it— it— it's closer to the 1 than it is to the 16— in terms of dilution because they would repurchase— the— they would use the proceeds they received in the options to repurchase shares. So— so— they said the breakdown between giving performance shares— in terms of what they call option equivalent, it would be 40 percent down and 60 percent options. If they repurchase the shares, it would not be— it would not be as low as 1 percent. It— it would be far from the— from the higher numbers.
In that response, it sounds like he's mentioning repurchases and option issuance as part of the same equation, whereas in his 1999 letter to shareholders, he said:
Of course, both option grants and repurchases may make sense — but if that’s the case, it’s not because the two activities are logically related. Rationally, a company’s decision to repurchase shares or to issue them should stand on its own feet. Just because stock has been issued to satisfy options — or for any other reason — does not mean that stock should be repurchased at a price above intrinsic value. Correspondingly, a stock that sells well below intrinsic value should be repurchased whether or not stock has previously been issued (or may be because of outstanding options).
I always enjoy Christopher Begg's letters, but this one I thought was especially good.
Link to: The Economy of Evolution
Link to: The Economy of Evolution
In our first quarter letter you will find our portfolio update and general market observations. Each quarter we highlight one component of our investment process. This quarter, in the section titled The Economy of Evolution, I will discuss business evolution and how some businesses are more fit for adaptation than others. I will illustrate a theme and new position in the portfolio that serves as a tangible example of the discussed concepts......
In an 1856 manuscript of On the Origin of Species, Darwin compared nature "to a surface covered with ten thousand sharp wedges . . . representing different species, all packed closely together and all driven in by incessant blows." Sometimes a wedge, a new species, driven deeply into this imaginary surface, would force out others, affecting species across "many lines of direction." This metaphor is an effective way to describe the interconnectivity of species and the importance of external impacts. Charles Darwin was influenced by his reading of Malthus’ prediction on population growth and how limited resources would lead to an eventual catastrophe. He used the hammering of wedges image as a metaphor to emphasize that there was limited space for organisms to adapt, and that their ability to do so depended not upon absolutes but upon niches.
Just like with species, businesses and investors face “Darwinian wedges.” These wedges can be subtly hammered in over time, or they can be more extreme, forcing immediate extinction of certain businesses. Wedges come in all forms: government regulation, a disruptive competitor, or environmental impact, to name a few.
Three Darwinian wedges we are following today are:
1. The Amazon Effect: Amazon is one of the greatest predators to brick and mortar retail commerce. The incessant hammering blow of a market share focus versus profit is, and continues to prove, a virtuous cycle. Just like the Wal-Mart effect on many small businesses, extinction is inevitable for those that cannot adapt to their changing food source.
2. Climate Change: The science seems overwhelmingly in support of a need to reduce the world’s global carbon footprint. There are many businesses and industries that will continue to help this effort toward emissions reduction, and there are emitting industries whose extinction seems inevitable.
3. Gas Evolution: Through advances in technology (horizontal and deep water drilling) the world has found a relatively clean energy source that can help significantly reduce carbon emissions and meet a growing world energy demand. To move natural gas we will need to re-plumb the world’s gas and oil supply chain – liquefaction, gasification, transportation, storage, as well as adapt geographically to where it makes economic sense to refine and store these energy assets.
Descent of Business:
An investor I respect shared a conversation with me that he had with Charlie Munger, who asked him, “What percent of businesses will be better ten years from now than they are today?” This investor’s answer was 15%. Charlie replied, “I would have said 20%, but you are right.”
The invaluable lesson is that most businesses fail to adapt. What made most businesses successful is likely not the exact same system that will drive their success into the future. While altruistic principles are forever static, systems often get crushed under the weight of change. For some large businesses, they also may face the law of large numbers, where it becomes increasingly more difficult to drive the level of change to have compounding benefits.
Link to interview: Big data, bad prophets and Brian Cox: An interview with Tim Harford
You write about economics for a wide audience, is that because you believe there’s some benefit in wider economic literacy?
I do, but I also just find it fascinating. I don’t think Brian Cox does The Wonders of the Solar System because he believes the world would be a better place if people understood about the rings of Saturn, I just think he finds physics extremely interesting. It brings him joy and he wants to spread the love. I feel the same about economics. Our society is intertwined with the economy that we’ve built, which is a fantastically complex system. I hope that my writing about it might do some good, but that’s not why I do it.
What do you think the wider public perception is of economics?
There’s a sort of split personality here. People widely feel that economics did not perform very well in the crisis, and yet they keep coming to economics for forecasts. Somehow people can’t quite kick the habit of asking economists for advice.
Economists are seen as prophets, then?
I think the association of economics with forecasting is unfortunate, and is down to the fact that one great way to get an investment bank’s name on business television is to hire a guy called a Chief Economist who will go and prognosticate. John Maynard Keynes famously said it would be splendid if economists were a competent humble profession like dentists. You would never ask your dentist to predict how many teeth you will have in 20 years’ time, or whether you will need to have your wisdom teeth out. You ask your dentist for advice on keeping your teeth healthy, and for help if you have a problem. Equally, economists should primarily aspire to give good advice about keeping the economy healthy.
Do you find it frustrating when economic bodies’ words get co-opted by journalists and politicians?
I never understand why “economist makes forecast” is ever a headline. Whether the economist in question is from the International Monetary Fund, a City forecasting group or the Treasury—a forecast is still not news.
Link to: World in flux
In a fast-changing world, business models have to keep pace. Creative destruction has served society better than 'too-big-to-fail'. Instability may lead to opportunity, and we are certainly on the lookout. A snag is that established business models are often disrupted by upstart innovators, and the latter are not only riskier, but often not open to investment. We'll keep looking.
Link to blog post: Body and Brain
The common view of human behavior is that thinking causes doing.
In recent years science has discovered this situation to be more of a bi-directional thing. For example, studies show that forcing a smile can lead to greater happiness. Most of you already knew that factoid. And obviously you understand that events in your environment and various sensations in your body can influence your mood and your thinking.
But I'll bet most of you hold the view that for the most part your thoughts lead to actions and that's 95% of the story of you. Lately I've come to the opposing view. I think our actions are the things that matter and our so-called minds are nothing but some executive control and a chemistry experiment.
I've been experimenting in the past year with the idea that I can control my thoughts by what I do with my body. Obviously my mind has to get the ball rolling to make me act in the first place. But instead of acting based on how I feel, I act based on how I WANT to feel. In other words, I use my body to control my future thoughts.
Yeah, yeah, you all do the same thing. I know. But it's a matter of degree. And it's a matter of how you THINK about your choices. A subtle shift in thinking can be a big deal.
For example, when feeling down, many people will curl up with some junk food and watch bad television shows until the feeling passes or some other duty calls. That's an example of letting your mind control your actions.
What I do in that situation is ask myself what is likely to cause a chemical improvement in my brain. Then I do that thing.
Related book: How to Fail at Almost Everything and Still Win Big: Kind of the Story of My Life (or, the audio book on an MP3 CD, which is currently just $8.14, HERE)
The videos are available HERE.
The transcript is available HERE.
There are a couple of excerpts from Snowball that Becky Quick could have been referring to when it came to the Coke/ham sandwich discussion, where Buffett essentially said he didn't make the 'ham sandwich' comment about Coke, implying that Alice Schroeder may have gotten the story slightly wrong. But below are a couple of excerpts from the book that may be the ones.
In 1997, Gates joined Buffett and Goizueta on a panel discussion at Sun Valley that was moderated by Keough.
“I used to talk to Bill all the time, and I’d always use this expression that a ham sandwich could runCoca-Cola. And Bill wasn’t quite housebroken then. So we were sitting on this panel, up in front of the audience, and Bill said something to the effect that it’s pretty easy to run Coke.”
“I was trying to make a point about how Coke is such a wonderful business,” says Gates, “and I said something about how I’m going to step down from Microsoft before I’m sixty because it’s a tough business and a young person may need to be in there to handle turns in the road. But it came across that I thought of Microsoft as exciting and I must have said something like, ‘Unlike Coca-Cola…’
“Goizueta thought I was an uppity, arrogant kid who was painting some kind of picture that I was engaged in some masterful act on a daily basis whereas anybody could leave at noon and go golfing if they ran Coca-Cola.”6
“And Roberto hated Bill from that point forward.”
Buffett avoided technology stocks partly because these fast-moving businesses could never be run by a ham sandwich. He thought it no shame to have a business that could be run by a ham sandwich; he wanted to get Berkshire Hathaway to the point that it could be run by a ham sandwich too—though not until after he was gone.
By 2008, Coca-Cola’s stock was up forty-five percent from its low, to $58. Profits had risen steadily under CEO Neville Isdell. He had settled the Department of Justice investigation and closed a $200 million discrimination lawsuit over racial bias. Buffett left the board in February 2006. His last Coca-Cola shareholder meeting had been another carnival of activists, but nobody had to be wrestled to the floor, and the tension was set to a lower thermostat. In 2007, Isdell had announced that he was retiring. The new CEO, Muhtar Kent, was responsible for the company’s successful push into non-cola drinks, where Coca-Cola had been lagging and was strategically off course.
“I always used to tell Gates that a ham sandwich could run Coca-Cola. And it was a damn good thing, too, because we had a period there a couple of years ago where, if it hadn’t been that great of a business, it might not have survived.”
Wednesday, April 23, 2014
Mr. Buffett abstained from voting on the Coca-Cola compensation plan. He said it was excessive, but that he could never vote against Coca-Cola. But the plan, as expected, did pass the shareholder vote.
Link to video: Buffett: Shareholders Should Speak Out on Coca-Cola
April 23 (Bloomberg) -- Warren Buffett, the billionaire chairman of Berkshire Hathaway, explains why he abstained from voting on Coca-Cola Co.’s plan to award employees with stock, how he feels about tech stocks and the U.S. housing recovery. He speaks with Betty Liu on Bloomberg Television's "Street Smart."
Intro from ValueWalk:
LINK TO VIDEO
Kyle Bass gave a presentation at the CFA SOCIETY DALLAS-FORT WORTH ANNUAL FORECAST DINNER on February 14th. A copy of the presentation has been obtained by ValueWalk. Below readers can find the full video of Kyle Bass speaking as well as the 20 pages, the theme of which was titled, ‘Hayman Global Outlook Pitfalls and Opportunities for 2014 ‘
LINK TO VIDEO
Link to article: The Moral Power of Curiosity
Most of us have at one time or another felt ourselves in the grip of the explanatory drive. You’re confronted by some puzzle, confusion or mystery. Your inability to come up with an answer gnaws at you. You’re up at night, turning the problem over in your mind. Then, suddenly: clarity. The pieces click into place. There’s a jolt of pure satisfaction.
We’re all familiar with this drive, but I wasn’t really conscious of the moral force of this longing until I read Michael Lewis’s book, “Flash Boys.”
As you’re probably aware, this book is about how a small number of Wall Street-types figured out that the stock markets were rigged by high-frequency traders who used complex technologies to give themselves a head start on everybody else. It’s nominally a book about finance, but it’s really a morality tale. The core question Lewis forces us to ask is: Why did some people do the right thing while most of their peers did not?
The answer, I think, is that most people on Wall Street are primarily motivated to make money, but a few people are primarily motivated by an intense desire to figure stuff out.
These people are content to possess information, but they don’t seek knowledge. Information is what you need to make money short term. Knowledge is the deeper understanding of how things work. It’s obtained only by long and inefficient study. It’s gained by those who set aside the profit motive and instead possess an intrinsic desire just to know.
Related book: Flash Boys
Related previous post: Michael Lewis in conversation with Malcolm Gladwell at Live Talks Los Angeles
Link to: Greenlight Capital Q1 2014 Letter
We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year. Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.
In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:
- The rejection of conventional valuation methods;
- Short-sellers forced to cover due to intolerable mark-to-market losses; and
- Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?
Given the enormous stock price volatility, we decided to short a basket of bubble stocks. A basket approach makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly. The corollary to “twice a silly price is not twice as silly” is that when the prices reconnect to traditional valuation methods, the derating can be substantial. There is a huge gap between the bubble price and the point where isciplined growth investors (let alone value investors) become interested buyers. When the last internet bubble popped, Cisco (the best of the best bubble stocks) fell 89%, Amazon fell 93%, and the lower quality stocks fell even more.
In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet. Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.
Tuesday, April 22, 2014
A great blog post from Philosophical Economics, and a great example of some of the things Sanjay Bakshi stresses, as well as one of the best examples of what Charlie Munger meant when he said: “"...if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."
On Thursday, October 3, 1974, the S&P 500 closed at , the definitive closing low of the brutal 1973-1974 bear market. The trailing twelve month PE ratio for the index at the time was . The yield on the 10 year treasury bond was , and the Fed Funds Rate was .
On that day, Wal-Mart Stores (NYSE: WMT) closed at . Its EPS for the prior fiscal year was . Its trailing PE ratio on that number was .
In that same period, Wal-Mart produced a nominal total return of roughly per year. With dividends reinvested, a investment in $WMT went on to become roughly . That same investment now pays more than each year in annual dividends–100 times the initial price.
The reason that Wal-Mart produced a fantastic return from 1974 to now is not that it was cheap relative to its present or near-term future earnings. By the standards of 1974, it was actually a growth stock–priced at almost twice the market multiple. In the current market, an equivalent valuation would be something like or times earnings–for a business with uncomplicated earnings that had already been in operation in Arkansas for three decades. It produced a fantastic return because it was a fantastic business, with miles and miles of growth still in front of it.
Suppose that we put into your pocket and teleport you back in time, onto the floor of the NYSE at 1PM on Thursday, October 3, 1974. You know what you know now, and you can buy whatever stock you want to buy. When the market closes, we’re going to teleport you back to the present, and your $10,000 investment will have turned into whatever it would have turned into, from then until today.
What are you going to buy? If you’re smart, you’re obviously going to buy $WMT–as much of it as you possibly can. You haven’t looked at any other names, therefore you can’t be sure of their performance. Exxon? Coca-Cola? You would equal perform the market. IBM? You would dramatically underperform. The only present-day blue-chip company that I can think of that would have even come close to matching Wal-Mart’s performance is Walgreen (WAG: NYSE). In $WAG, a investment in 1974 would have turned into .
Now, what is the maximum price that you should be willing to pay for $WMT, knowing what it’s going to become? And what sort of valuation would this price imply? One way to answer the question would be to discount $WMT’s total return from 1974 to today at the rate of return of the overall market. $WMT at produced a 40 year annual total return of . It turns out that the price that would bring this return down to the market rate, , is roughly .
In 1974, for a $WMT share would have represented a PE ratio of more than . In the current market, which is much richer, this would be the equivalent of something like times trailing earnings–again for a company with undistorted earnings that has been in operation for decades.
To account for risk and uncertainty, which doesn’t exist for you, but does exist for anyone that’s not traveling through time, suppose that we cut our maximum fair price for $WMT by . Then we cut it in half. Then we cut it in half again. Normalized to the 2014 market, the multiple would still be roughly times earnings. Many people would balk at such a “rich” price–but for $WMT, it arguably would have been, and arguably actually was, the single greatest buying opportunity of that generation.
The next time we see an excellent business trading at 40 times earnings, or 75 times earnings, or 100 times earnings, or wherever, and we shy away, it might help to remember the example of Wal-Mart. High multiples can be entirely justified, provided that the growth potential is real. We definitely should remember the example if we ever come under the temptation to short individual names based on valuation concerns. Nothing is riskier or more imprudent than to short a high-quality business with an uptrending stock price, simply because we think the price is too high. It can always go higher–often, it go higher, for fundamentally valid reasons that we’ve failed to appreciate.
Monday, April 21, 2014
Carl Sagan’s daughter also just wrote a nice article for New York Magazine…
Link to article: Lessons of Immortality and Mortality From My Father, Carl Sagan
Then he told me, very tenderly, that it can be dangerous to believe things just because you want them to be true. You can get tricked if you don’t question yourself and others, especially people in a position of authority. He told me that anything that’s truly real can stand up to scrutiny.
As far as I can remember, this is the first time I began to understand the permanence of death. As I veered into a kind of mini existential crisis, my parents comforted me without deviating from their scientific worldview.
“You are alive right this second. That is an amazing thing,” they told me. When you consider the nearly infinite number of forks in the road that lead to any single person being born, they said, you must be grateful that you’re you at this very second. Think of the enormous number of potential alternate universes where, for example, your great-great-grandparents never meet and you never come to be. Moreover, you have the pleasure of living on a planet where you have evolved to breathe the air, drink the water, and love the warmth of the closest star. You’re connected to the generations through DNA — and, even farther back, to the universe, because every cell in your body was cooked in the hearts of stars. We are star stuff, my dad famously said, and he made me feel that way.
My parents taught me that even though it’s not forever — because it’s not forever — being alive is a profoundly beautiful thing for which each of us should feel deeply grateful. If we lived forever it would not be so amazing.
[H/T Lincoln] These 1977 Christmas Lectures are similar to the 1991 Christmas Lectures by Richard Dawkins, HERE, which discussed evolution.
Link to: Hoisington Q1 2014 Letter
The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger. The preponderance of research suggests that the FOMC has been incorrect in its presumption of the effectiveness of quantitative easing (QE) on boosting economic growth. This faulty track record calls into question their latest prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015.
A major reason for the FOMC’s overly optimistic forecast for economic growth and its incorrect view of the effectiveness of quantitative easing is the reliance on the so-called “wealth effect”, described as a change in consumer wealth which results in a change in consumer spending.
Extraordinary market returns and dismal market returns both come from somewhere. Long periods of outstanding market returns have their origins in depressed valuations. Long periods of dismal market returns have their origins in elevated valuations. The best way to understand the returns that investors can expect over the long-term is to have a firm understanding of where reliable measures of valuation stand at each point in time.
A few quick valuation studies may be helpful. As the workhorse for these studies, we'll use the ratio of market capitalization to GDP. Warren Buffett observed in a 2001 Fortune interview that "it is probably the best single measure of where valuations stand at any given moment."
A variety of normalized earnings measures could be used as well, but emphatically, what should not be used is any price/earnings measure that is not adjusted for the variation of profit margins over the economic cycle. That includes the "Fed Model" and any number of "equity risk premium" measures, which actually have a rather weak correlation with actual subsequent market returns. For more evidence on why margin variation is important to consider, see Margins, Multiples, and the Iron Law of Valuation.
Sunday, April 20, 2014
Video from a Live Talks Los Angeles event with Michael Lewis in conversation with Malcolm Gladwell held on April 10, 2014. The occasion was the release of Michael Lewis' book, "Flash Boys: A Wall Street Revolt."
Link to video
Related book: Flash Boys (I finished listening to the AUDIO BOOK last week, which was a great listen.)
Friday, April 18, 2014
Link to: Jamie Dimon's Letter to Shareholders
The Fed’s balance sheet has gone from $1 trillion in 2007 to an estimated $4.5 trillion by the end of this year. Some feel the Fed’s QE policies have been too aggressive and ultimately will be inflationary. Additionally, there is a fear that ending QE will be risky and complex, particularly since QE has little precedence.
We cannot predict the future, and it is rational to have a healthy fear of new and untested policies. However, we think it will be helpful to put some of these issues in perspective, too.
Thursday, April 17, 2014
British Pathé was one of the leading producers of newsreels and documentaries during the 20th Century. This week, the company, now an archive, is turning over its entire collection — over 85,000 historical films – to YouTube.
The archive — which spans from 1896 to 1976 – is a goldmine of footage, containing movies of some of the most important moments of the last 100 years. It’s a treasure trove for film buffs, culture nerds and history mavens everywhere.
The videos are available to watch HERE.
An excerpt from Warren Buffett’s 1957 letter that may be useful to think about in regards to current stock market levels:
In last year's letter to partners, I said the following:
My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both undervalued and otherwise. In any event I think the probability is very slight that current market levels will be thought of as cheap five years from now. Even a full-scale bear market, however, should not hurt the market value of our work-outs substantially.
If the general market were to return to an undervalued status our capital might be employed exclusively in general issues and perhaps some borrowed money would be used in this operation at that time. Conversely, if the market should go considerably higher our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio.
All of the above is not intended to imply that market analysis is foremost in my mind. Primary attention is given at all times to the detection of substantially undervalued securities.
The past year witnessed a moderate decline in stock prices. I stress the word "moderate" since casual reading of the press or conversing with those who have had only recent experience with stocks would tend to create an impression of a much greater decline. Actually, it appears to me that the decline in stock prices has been considerably less than the decline in corporate earning power under present business conditions. This means that the public is still very bullish on blue chip stocks and the general economic picture. I make no attempt to forecast either business or the stock market; the above is simply intended to dispel any notions that stocks have suffered any drastic decline or that the general market, is at a low level. I still consider the general market to be priced on the high side based on long term investment value.
Link to podcast: IS INCLUSIVE DEVELOPMENT POSSIBLE?
What has Malaysia’s economic and political trajectory been since its formation? Was the May 13th incident and the suspension of Parliament a derailment of the positive trajectory that we were on? Professor Woo, President of the newly established Jeffrey Cheah Institute on Southeast Asia, talks about the watershed moment in the country’s recent economic history and argues for a bi-partisan consensus around “an inclusive national development” plan as the only way forward.
[H/T Claire Barnes]
Wednesday, April 16, 2014
Link to free Kindle book: Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market
The author's (Meb Faber) description:
Our newest book is free on Amazon for the next five days, so download a copy now and let us know what you think!
If you don't have a Kindle or iPad you can download the Kindle software to your computer. It looks best on a device that allows color since there are over 35 charts and tables.
You can also find more information on our new ETF, the Cambria Global Value (GVAL) on our website here:
UPDATE: His book from last year is free on Kindle as well, HERE.
Tuesday, April 15, 2014
Link to video: Cosmos: A Spacetime Odyssey: Deeper, Deeper, Deeper Still
Quote this episode brought to by mind:
“I, a universe of atoms, an atom in the universe.” ―Richard P. Feynman
“Say to yourself first thing in the morning: today I might meet with people who are meddling, ungrateful, aggressive, treacherous, malicious and unsocial. All this has afflicted them through their ignorance of true good and evil. But I have seen that the nature of good is what is right, and the nature of evil what is wrong; and I have reflected that the nature of the offender himself is akin to my own - not a kinship of blood or seed, but a sharing in the same mind, the same fragment of divinity. Therefore I cannot be harmed by any of them, as none will infect me with their wrong. Not can I be angry with my fellow human being or hate him. We were born for cooperation, like feet, like hands, like eyelids, like the rows of upper and lower teeth. So to work in opposition to one another is against nature: and anger or rejection is opposition.” -Marcus Aurelius
Monday, April 14, 2014
“Let us go to our sleep with joy and gladness; let us say 'I have lived; the course which Fortune set for me is finished.' And if God is pleased to add another day, we should welcome it with glad hearts. That man is happiest, and is secure in his own possession of himself, who can await the morrow without apprehension. When a man has said: 'I have lived!', every morning he arises he receives a bonus.” –Seneca
The equity market remains valued at nearly double its historical norms on reliable measures of valuation (though numerous unreliable alternatives can be sought if one seeks comfort rather than reliability). The same measures that indicated that the S&P 500 was priced in 2009 to achieve 10-14% annual total returns over the next decade presently indicate estimated 10-year nominal total returns of only about 2.7% annually. That’s up from about 2.3% annually last week, which is about the impact that a 4% market decline would be expected to have on 10-year expected returns. I should note that sentiment remains wildly bullish (55% bulls to 19% bears, record margin debt, heavy IPO issuance, record “covenant lite” debt issuance), and fear as measured by option volatilities is still quite contained, but “tail risk” as measured by option skew remains elevated. In all, the recent pullback is nowhere near the scale that should be considered material. What’s material is the extent of present market overvaluation, and the continuing breakdown in market internals we’re observing. Remember – most market tops are not a moment but a process. Plunges and spikes of several percent in either direction are typically forgettable and irrelevant in the context of the fluctuations that occur over the complete cycle.
The Iron Law of Valuation is that every security is a claim on an expected stream of future cash flows, and given that expected stream of future cash flows, the current price of the security moves opposite to the expected future return on that security. Particularly at market peaks, investors seem to believe that regardless of the extent of the preceding advance, future returns remain entirely unaffected. The repeated eagerness of investors to extrapolate returns and ignore the Iron Law of Valuation has been the source of the deepest losses in history.
A corollary to the Iron Law of Valuation is that one can only reliably use a “price/X” multiple to value stocks if “X” is a sufficient statistic for the very long-term stream of cash flows that stocks are likely to deliver into the hands of investors for decades to come. Not just next year, not just 10 years from now, but as long as the security is likely to exist. Now, X doesn’t have to be equal to those long-term cash flows – only proportional to them over time (every constant-growth rate valuation model relies on that quality). If X is a sufficient statistic for the stream of future cash flows, then the price/X ratio becomes informative about future returns. A good way to test a valuation measure is to check whether variations in the price/X multiple are closely related to actual subsequent returns in the security over a horizon of 7-10 years.