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Graham and Dodd "look for values with a significant margin of safety relative to prices" approach to security analysis out of date?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."
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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."
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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."
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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."
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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."
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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."
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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."
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CNBC Squawk Box Interview, January 20, 2010