Wednesday, February 17, 2010

Buffett's Investment Record-Luck or Skill?

Nassim Taleb, author of Black Swan, was recently quoted as saying "I'm not saying Buffett doesn't have skill-I'm just saying we don't have enough evidence to say Buffett isn't doing it by chance."

For the record, over the past 45 years the book value of Berkshire Hathaway's stock has grown at a rate of 20% plus while the Standard & Poors 500 index has appreciated by a rate of 10% plus. It's difficult to understand what evidence Mr Taleb is missing.

I suggest that he read Mr. Buffett's article, The Superinvestors of Graham-and-Doddsville, an edited transcript of a talk he gave at Columbia University in 1984.

A few excerpts follow:

Is the Graham and Dodd "look for values with a significant margin of safety relative to prices" approach to security analysis out of date? Many of the professors who write textbooks today say yes. They argue that the stock market is efficient; that is, that stock prices reflect everything tat is known about a company's prospects and about the state of the economy. There are no undervalued stocks, these theorists argue, because there there are smart analysts who utilize all available information to ensure unfailingly appropriate prices. Investors who seem to beat the market year after year are just lucky......Well, maybe. But I want to present you with a group of investors who have, year in and year out, beaten the Standard & Poors 500 stock index.

The common intellectual theme of the investors of Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.....Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of interest to them. In fact, most of them would have difficulty defining these terms. The investors simply focus on two variables: price and value.

While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock.

I urge Mr. Taleb read the entire article, which many consider to be the best on investing ever written.

Saturday, February 6, 2010

Buffett on Corporate Debt

In a rare move, on February 4, Berkshire Hathaway issued $8 billion of new debt (5.75% notes due January 15, 1940) in connection with its acquisition of Burlington Northern Santa Fe Corp.

In her comments on the issuance, Margie Patel, a senior portfolio manager at Evergreen Investment in Boston, said: "Warren Buffett is taking advantage of an extremely attractive time to finance, with borrowing costs near all time lows due to narrow Treasury yields and an insatiable appetite evident among investors."
Romy Varghese and Kellie Geressy-Nelson, Wall Street Journal, February 5, 2010

Over the past 30 years, in his shareholder letters, Buffett has written about the appropriate type and the timing of the issuance of corporate debt.

"Except for token amounts....We are not interested in incurring any significant debt at Berkshire for acquisition or operating purposes. Conventional business wisdom, of course, would argue that we are being too conservative and that there are added profits that could be safely earned if we injected moderate leverage into our balance sheet."
2005 Letter to Berkshire Hathaway Shareholders

"We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leaverage our balance sheet. This conservatism has penalized our results but it the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. As one of the Indianapolis "500" winners said: "To finish first, you must first finish."
1996 Letter to Berkshire Hathaway Shareholders

"In general, we continue to have an adversion to debt, particularly the short-term kind. But we are willing to incur modest amounts of debt when it is porperly structured and of significant benefit to shareholders."
1992 Letter to Berkshire Hathaway Shareholders

"Unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it. A business obtains the best financial results possible by managing both sides of its balance sheet well. This means obtaining the highest-possible rturn on assets and the lowest-possible cost on liabilities. It would be convenient if opportunities for intelligent action on both fronts coincided. However, reason tells us that just the opposite is likely to be the case. Tight money conditions which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side."
1987 Letter to Berkshire Hathaway Shareholders

"Unlike most businessses, Berkshire did not finance because of any specific immediate needs. Rather, we borrowed because we think that, over a period far shorter than the life of the loan, we will have many opportunities may present themseves at a time when credit is extremely expensive-or even unavailable. At such a time we want to have plenty of financial firepower."

1980 Letter to Berkshire Hathaway Shareholders

Wednesday, February 3, 2010

"I want that CEO equation to be that if this place goes down or needs government help, I'm busted."

In his January 20, 2010 CNBC Squawk Box interview, Buffett presents his solution to change future behavior of bank management and directors.

"I think, and I'm not even sure how you draft this into statutes, but the banks that got into big trouble, it was management at the top. And a number of those went away rich. They didn't go away as rich as they were earlier, but I think that's terrible. I think, if I were on the board of directors of a bank, and you do this in conjunction with the government, but I think you should have something so that if a bank ever has to go to the Federal government, not to the FDIC because that's a form of insurance, but if they have to go to the Federal government to be saved, the CEO and any CEO of the previous two years before that, and his wife, they sign something so that they are essentially wiped out. If an institution that's so important to this country really causes the country great difficulty, I think the CEO, I want that CEO's equation to be that if this place goes down or needs government help, I'm busted. And I can't put it all in my wife's name and she's busted, too. And then I would have strict penalties for directors, probably five times their average compensation or something. I think that would do more to change behavior, the kind of behavior that gets us into trouble, then anything else you could do."
CNBC Squawk Box Interview, January 20, 2010

Sunday, January 31, 2010

I'm Sorry

In yesterday's New York Times, Alina Tugend writes:

"There has been a fair amount in the news lately about apologies, particularly whether the chief executive officers of financial institutions have been contrite enough about the role they played in bringing about this recession......When you refuse to apologize for a wrong or are told by a lawyer or insurer not to do it "dismantles one of life's most basic moral lessons-owning up to our mistakes, Profeesor Cohen, of the University of Florida, says."
Alina Tugend, An Attempt to Revive The Lost Art of Apology, New York Times, January 30, 2010

Warren Buffett would agree. In 1991, in response to the impending collapse of Salomon Brothers
resulting from illegal trading, he says:

“ We did wrong. We ’ re going to show how we did wrong. We ’ ve signed the charge sheet. I would like to start by apologizing for the acts that have brought us here. The Nation has a right to expect its rules and laws will be obeyed. At Salomon, certain of these were broken.
I want employees to ask themselves whether they are willing to have any contemplated act appear on the front page of their local paper the next day, to be read by their spouses, children
and friends . . . . If they follow this test, they need not fear my other message to them: Lose money for the firm, and I will be understanding; lose a shred of reputation for the fi rm, and I
will be ruthless. ”

Roger Lowenstein, Buffett: The Making of an American Capitalist (New York: Random House, 1995)

Saturday, January 30, 2010

Women on Wall Street

In today's New York Times, Geraldine Fabricant writes:

"When Sallie Krawcheck was hired six months ago as president of global wealth and investment management at Bank of America, she was besieged with e-mail messages from current and former Wall Street women celebrating her return to the fray.

Ms. Krawcheck had been forced out as head of a comparable unit at Citigroup in August 2008, a highly publicized departure. Hers has been the only comeback among the three highest-ranking Wall Street women removed during the financial crisis.

I don’t think I set foot in a restaurant where some woman did not come up to me and thank me for getting knocked around and going back in,” Ms. Krawcheck, 45, recalled in an interview at Bank of America’s corporate office in New York. “It was unexpected and quite fantastic.”
The outpouring over Ms. Krawcheck’s return reflects deep anxiety among women in the financial industry that their career paths are narrowing even as business picks up again."
Geraldine Fabricant, Fewer Women Betting on Wall Street Careers, New York Times, January 30, 2010

Warren Buffett has always been very pro-woman. He was one of only a handful of men invited to speak at the The Fortune Most Powerful Women Summit, recently held in San Francisco. In a remarkable interview with Charlie Rose in 2004, Susie Buffett, Warren’s deceased wife, said:

“I find this a profound thing. I was talking to him one day on some racial issue, and he looked at me, and this Charlie, would have been 40 years ago. And he said to me, wait till women discover they’re the slaves of the world. Now how many men were cognitive of that and even women then? I am so impressed by that, and he’s very, very pro-women….He likes women. Yeah, he does, well why shouldn’t he?....My dad always said that women were the superior gender. And if women ruled the world, it would be a much better place. So I came from a father who loved women, and Warren feels that women all over the world get short-changed…. That’s why he is for eyerything that helps women be part of a level playing field.”
Susie Buffett, Charlie Rose Interview, PBS 2004

A few striking examples of Berkshire women executives follow:

"About 67 years ago, Mrs. Blumpkin, then 23 talked her way past a border guard to leave Russia for America, She had no formal education, not even at the grammar school level, and knew no English. After some years in this country, she learned the language when her older daughter taught her, every evening, the words she had learned in school during the day.

In 1937, after many years of selling used clothing, Mrs. Blumpkin had saved $500 with which to realize her dream of operating a furniture store. Upon seeing the American Furniture Mart in Chicago-then the center of the nation’s wholesale furniture activity-she decided to christen her dream Nebraska Furniture Mart.

She met every obstacle you would expect (and a few you wouldn’t) when a business endowed with only $500 and no locational or product advantage goes up against rich, long-entrenched competition. At one early point, when her tiny resources ran out, “Mrs B” (a personal trademark now as well recognized in Greater Omaha as Coca Cola or Sanka) coped in a way not taught at business schools: she simply sold the furniture and appliances from her home in order to pay creditors precisely as promised........

Today Nebraska Furniture Mart generates over $100 million of sales annually out of one 200,000 square-foot store. No other home furnishings store in the country comes close to that volume. That single store also sells more furniture, carpets, and appliances than do all Omaha competitors combined."
Warren Buffett, 2003 Berkshire Hathaway Shareholder Letter

"They would learn the essence of business. They would learn that taking care of customers is what it is all about. Taking care of them. I mean by that, giving them good deals, which nobody would touch. She did and working like crazy she was there day after day. She had a passion for it. The truth is, if you took the Fortune 500 CEO’s and I gave you the first draft pick on 10 of them, and I put them in competition with her; she would win." ________________________________________________
Warren Buffett, Charlie Rose Interview, PBS 2004

Susan came to Borsheims 25 years ago as a $4-an-hour saleswoman. Though she lacked a managerial background, I did not hesitate to make her CEO in 1994. She’s smart, she loves the business, and she loves her associates. That beats having an MBA degree any time.

(An aside: Charlie and I are not big fans of resumes. Instead, we focus on brains, passion and integrity. Another of our great managers is Cathy Barron Tamraz, who has significantly increased Business Wire’s earnings since we purchased it early in 2006. She is an owner’s dream. It is positively dangerous to stand between Cathy and a business prospect. Cathy, it should be noted, began her career as a cab driver.)
Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders

Tuesday, January 26, 2010

A Tax Inefficient Sale

In his recent CNBC Squawk Box interview, Warren Buffett was sharply critical of Kraft management's decision to sell its pizza business to Nestle, and unnecessarily incurring a $1.2 billion tax bill to do so.

"Well, I think-I think Kraft has got a wonderful portfolio of businesses including their pizza business which Nestle now has, having paid $1.2 billion more for it than we received in terms of cash......

Well, when you look closely, you find $3.7 billion becomes $2.5 billion. And it was an enormously tax inefficient way to get rid of it. If you wanted to sell it, it was tax inefficient. Back when Kraft got rid of Post cereals, they did it in a tax efficient way. It's not that they don't know how to do it, but in this case, they did it in an enormously tax-inefficient way. When you have a business with virtually no basis, Procter & Gamble's gone through this, Kraft, other people. There are ways to handle spinoffs that avoid cutting the government in for almost one-third ownership of the business. And unfortunately, they headlined the $3.7 billion. I don't think I have read anyplace about the fact that they're only getting $2.5 billion. And it was Nestle that pointed out that this business does $2.1 billion in sales and makes $280 million. And giving up $280 million of earnings in a business that's been growing over the years for $2.5 billion of cash, I think, is a big mistake and I think it's a bigger mistake when you're paying -probably counting all of the costs involved including the undervaluation of the Kraft shares given, you're probably paying in the range of maybe 17 times earnings for Cadbury, I think is a big mistake."
CNBC Squawk Box Interview, January 20, 2010

Monday, January 25, 2010

The Kraft Acquisition of Cadbury-Part 1

Last week, in an extraordinarily candid intrview on CNBC, Warren Buffett stated his views on a wide range of topics, including his strong disagreement with Kraft's board of directors' corporate governance and management's decisions in connection with the acquisition of Cadbury. His corporate governance concerns follow:

".....for the people that pay attention to corporate governance, Kraft issued a 78-page proxy statement close to a month ago. And the sole issue was the issuance of 370 million shares of Kraft stock. That was the only thing to be voted on. And in 78 pages, thay told you about a deal that wasn't going to happen, and they told you a lot of other things about how the directors recommended this and everything else. There's one thing they didn't tell you. They didn't tell you what the directors-how the directors felt about the value of Kraft stock. Now, after I came out and said the stock was undervalued, the directors immediately came out and said that they thought it was undervalued, too. What point could possibly be more important when asking shareholders to vote on issuing 370 million shares is the director's views on whether they were going to get fairer value for these shares? In other words, if the directors thought those shares were significantly undervalued, when they issued that proxy statement, I think they had the duty to tell shareholders that they felt that way. Otherwise, you know, the shareholdrs could assume that they were getting fairer value for the shares."
CNBC Squawk Box Interview, January 20, 2010