Category Archives: Marketable securities

Warren Buffett’s Rip Van Winkle approach

ripvanwinle
Statue of Rip van Winkle in Irvington, New York, not far from “Sunnyside”, the home of Washington Irving. – Wikipedia

In his letter (dated February 28, 1992 for FY1991) to Berkshire Hathaway shareholders, Warren Buffett gave an insight into his Rip Van Winkle approach to investing. Referring to a list of Berkshire Hathaway’s common stock holdings – comprising Capital Cities/ABC Inc, The Coca-Cola Company, Federal Home Loan Mortgage Corp, GEICO Corp, The Gillette Company, Guinness PLC,  The Washington Post Company and Wells Fargo & Company – Warren Buffett said:  “As usual the list reflects our Rip Van Winkle approach to investing. Guinness is a new position. But we held the other seven stocks a year ago (making allowance for the conversion of our Gillette position from preferred to common) and in six of those we hold an unchanged number of shares. The exception is Federal Home Loan Mortgage (“Freddie Mac”), in which our shareholdings increased slightly. Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.

“(With tongue only partly in check, I suggest that recent events indicate that the much-maligned “idle rich” have received a bad rap: They have maintained or increased their wealth while many of the “energetic rich” – aggressive real estate operators, corporate acquirers, oil drillers, etc. – have seen their fortunes disappear.) Our Guinness holding represents Berkshire’s first significant investment in a company domiciled outside the United States. Guinness, however, earns its money in much the same fashion as Coca-Cola and Gillette, U.S.-based companies that garner most of their profits from international operations. Indeed, in the sense of where they earn their profits – continent-by-continent – Coca- Cola and Guinness display strong similarities. (But you’ll never get their drinks confused – and your Chairman remains unmovably in the Cherry Coke camp.) ”

Warren Buffett then went on to give an insight into his selection criteria, saying: “We continually search for large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements. This focus doesn’t guarantee results: We both have to buy at a sensible price and get business performance from our companies that validates our assessment. But this investment approach – searching for the superstars – offers us our only chance for real success. Charlie and I are simply not smart enough, considering the large sums we work with, to get great results by adroitly buying and selling portions of far-from-great businesses. Nor do we think many others can achieve long-term investment success by flitting from flower to flower. Indeed, we believe that according the name “investors” to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”

Notable quote

This statement from Warren Buffett is worth repeating here: “Nor do we think many others can achieve long-term investment success by flitting from flower to flower. Indeed, we believe that according the name “investors” to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”

Warren Buffett continued: “If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long- term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products? (I was tempted to say “the real thing.”) Our motto is: “If at first you do succeed, quit trying.” ”

Warren Buffett then went on to share this view: ” John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . . One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.”

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Marketable securities: operating results count

“In the short run, the market is a voting machine but in the long run it is a weighing machine.” – Benjamin Graham (photo: Wikipedia) was quoted by Warren Buffett as saying this.

In his letter (dated February 29, 1988 for FY1987) to Berkshire Hathaway shareholders, Warren Buffett talked about Mr Market, the character used by his teacher and friend Benjamin Graham to personify the behavior of the market. Mr Market has uncontrollable emotional problems. Then Warren Buffett went on to say: “Following Ben’s teachings, Charlie and I let our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it. As Ben said: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” The speed at which a business’s success is recognized, furthermore, is not that important as long as the company’s intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.

“Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In
such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even undervalued because
we require funds for a still more undervalued investment or one we believe we understand better.

“We need to emphasize, however, that we do not sell holdings just because they have appreciated or because we have held them
for a long time. (Of Wall Street maxims the most foolish may be “You can’t go broke taking a profit.”) We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business. However, our insurance companies own three marketable common stocks that we would not sell even though they became far overpriced in the market. In effect, we view these investments exactly like our successful controlled businesses – a permanent part of Berkshire rather than merchandise to be disposed of once Mr. Market offers us a sufficiently high price. To that, I will add one qualifier: These stocks are held by our insurance companies and we would, if absolutely necessary, sell portions of our holdings to pay extraordinary insurance losses. We intend, however, to manage our affairs so that sales are never required.

“A determination to have and to hold, which Charlie and I share, obviously involves a mixture of personal and financial considerations. To some, our stand may seem highly eccentric. (Charlie and I have long followed David Oglivy’s advice: “Develop your eccentricities while you are young. That way, when you get old, people won’t think you’re going ga-ga.”) Certainly, in the transaction-fixated Wall Street of recent years, our posture must seem odd: To many in that arena, both companies and stocks are seen only as raw material for trades.

“Our attitude, however, fits our personalities and the way we want to live our lives. Churchill once said, “You shape your houses and then they shape you.” We know the manner in which we wish to be shaped. For that reason, we would rather achieve a return of X while associating with people whom we strongly like and admire than realize 110% of X by exchanging these relationships for uninteresting or unpleasant ones. And we will never find people we like and admire more than some of the main participants at the three companies – our permanent holdings – shown below:

No. of shares Cost Market
3,000,000 Capital Cities/ABC, Inc $517,500 1,035,000
6,850,000 GEICO Corporation 45,713 756925
1,727,765 The Washington Post Company 9,731 323,092

“We really don’t see many fundamental differences between the purchase of a controlled business and the purchase of marketable holdings such as these. In each case we try to buy into businesses with favorable long-term economics. Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price. Charlie and I have found that making silk purses out of silk is the best that we can do; with sow’s ears, we fail.”

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

 

Why Warren Buffett wants IBM shares to languish…

ibmBerkshire Hathaway’s common stock investments include IBM or International Business Machines Corp. Based on Warren Buffett’s annual letter to shareholders dated February 25, 2012, for FY2011, Berkshire Hathaway has a stake of 5.5% in IBM.

Given this 5.5% IBM stake, why did Warren Buffett said this in his annual letter: “We should wish for IBM’s stock price to languish throughout the five years.”

The answer lies in IBM’s repurchase program.

In Warren Buffett’s own words: “Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares…

“Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

” If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the ‘disappointing’ scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1 1⁄2 billion more than if the ‘high-price’ repurchase scenario had taken place.

“The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”

Related post: Why Warren Buffett sold about one-third of stake in IBM

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Warren Buffett invests in IBM

ibmIn 2011, in what appeared to be another sign of Warren Buffett triggering his elephant gun, reports said the Berkshire Hathaway chairman had invested over US$10 billion in IBM.

A Reuters report (Nov 24, 2011) headlined “Buffett sheds tech aversion with big IBM investment” said: “Warren Buffett has always made his distaste for technology investments clear, but on Monday he changed his ways in spectacular fashion. The Berkshire Hathaway chief executive said he has bought nearly $11 billion of International Business Machines Corp (IBM) stock in the last eight months, building a roughly 5.5 percent stake that potentially makes him the largest shareholder in the company.”

Mr Buffett was quoted as saying in an interview on cable television network CNBC that he was struck by IBM’s ability to retain corporate clients, which made it indispensable in a way that few other services were.

As to why Mr Buffett triggered the elephant gun could probably be seen in Mr Buffett’s letter to shareholders on February 26, 2011 for Year 2000.

In the letter, Mr Buffett said: “Charlie and I hope that the per-share earnings of our non-insurance businesses continue to increase at a decent rate. But the job gets tougher as the numbers get larger. We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”

One can get an insight into the type of businesses that Warren Buffett and Berkshire Hathaway look for from his letter to shareholders (February 2008) for Year 2007.

“Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.”

Related post: Why Warren Buffett sold about one-third of stake in IBM

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Berkshire Hathaway’s Big Four marketable securities

Warren Buffett’s views on Berkshire Hathaway’s Big Four marketable securities can be seen in his annual letter (dated February 25, 2012 for FY2011) to Berkshire Hathaway shareholders: “…we now have large ownership interests in four exceptional companies: 13.0% of American Express, 8.8% of Coca-Cola, 5.5% of IBM and 7.6% of Wells Fargo. (We also, of course, have many smaller, but important, positions.) We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects.

“Our share of their earnings, however, are far from fully reflected in our earnings; only the dividends we receive from these businesses show up in our financial reports. Over time, though, the undistributed earnings of these companies that are attributable to our ownership are of huge importance to us. That’s because they will be used in a variety of ways to increase future earnings and dividends of the investee. They may also be devoted to stock repurchases, which will increase our share of the company’s future earnings. Had we owned our present positions throughout last year, our dividends from the ‘Big Four’ would have been $862 million. That’s all that would have been reported in Berkshire’s income statement.

“Our share of this quartet’s earnings, however, would have been far greater: $3.3 billion. Charlie and I believe that the $2.4 billion that goes unreported on our books creates at least that amount of value for Berkshire as it fuels earnings gains in future years. We expect the combined earnings of the four – and their dividends as well – to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us.”

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

How Warren Buffett picks marketable securities

wallstreetfreeWarren Buffett said in his letter to shareholders in the 1977 annual report that Berkshire Hathaway selected marketable equity securities in much the same
way it would evaluate a business for acquisition in its entirety.
Warren Buffett said then: “We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects
, (3) operated by honest and
competent people
, and (4) available at a very attractive price.”
The fourth point, “available at a very attractive price”, was changed to “available at an attractive price” in his letter to shareholders in the 1992 annual report.
“We have seen cause to make only one change in this creed: Because of both
market conditions and our size, we now substitute an attractive
price’ for ‘a very attractive price’,” Warren Buffett said in the 1992 annual report.
The consistency of Berkshire Hathaway’s investment creed can be seen in Warren Buffett’s letter to shareholders in the 2007 annual report.
Warren Buffett said then: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.” “Charlie” refers to Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway.

Recommended reading:
Berkshire Hathaway Letters to Shareholders, 1965-2013