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

Warren Buffett, who owned about 81 million shares in IBM at the end of 2016, sold off about a third of that stake in the first and second quarters of 2017.

He told CNBC this in a report dated May 4, 2017 (Warren Buffett has sold IBM shares, and ‘revalued’ tech icon downward, cites ‘big strong competitors’).

Mr Buffett’s FY2016 letter to Berkshire Hathaway, of which he is chairman and CEO, showed that at end-2016, the company owned  81,232,303 shares in IBM. The cost was US$13,815 million. “This is our actual purchase price and also our tax basis; GAAP “cost” differs in a few cases because of write-downs that have been required under GAAP rules,” said Mr Buffett in the shareholder letter.

Berkshire Hathaway first bought into IBM in 2011. 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.”

At that time in 2011, Mr Buffett was also  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.

Why then did he slash the stake in 2017? The CNBC May 4, 2017, report on Mr Buffett’s slashing of the IBM stake quoted him as saying: “I don’t value IBM the same way that I did 6 years ago when I started buying… I’ve revalued it somewhat downward.”

“When it got above $180 we actually sold a reasonable amount of stock,” said Mr Buffett.

According to Mr Buffett, IBM hadn’t performed the way he had expected — or the way IBM’s management had expected — when he first started buying the shares six years ago.

“IBM is a big strong company, but they’ve got big strong competitors too,” said Mr Buffett.

Mr Buffett also said he had stopped selling. At that point, IBM shares were trading below US$160.

What stocks to buy: 15 points to look for

“What are the matters about which the investor should learn if he is to obtain the type of investment which in a few years might show a gain of several hundred per cent, or over a longer period of time might show a correspondingly greater increase?

” In other words, what attributes should a company have to give it the greatest likelihood of attaining this kind of results for its shareholders?”

Common Sense And Uncommon Profits by Philip A. Fisher, in answering these questions, gives the fifteen points to look for in a common stock:

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

Companies which decade by decade have consistently shown spectacular growth might be divided into two groups:  “fortunate and able” and “fortunate because they are able”.  A high order of management ability is a must for both groups as no company grows for a long period of years just because it is lucky.

An example of the “fortunate and able” group is The Aluminium Company of America, says Philip Fisher.  The founders of this company were men with great vision. They correctly foresaw important commercial uses for their new product. However, neither they nor anyone else at that time could foresee anything like the future size of the market for aluminium products that was to develop over the next seventy years.

Du Pont is an example of the other group of growth stocks – the “fortunate because they are able” group –  says Philip Fisher.

This company was not originally in the business of making nylon,  cellophane, Lucite, neoprene, orlon, milar or any of the many other glamorous products with which it is frequently associated  in the public mind and which have proven so spectacularly profitable to the investor.

“Applying the skills and knowledge learned in its original powder business, the company has successfully launched product after product to make one of the great success stories of American stories,” says Common Stocks And Uncommon Profits.

 

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

The investor usually obtains the best results in companies whose engineering or research is to a considerable extent devoted to products having some business relationship to those already within the scope of company activities, says Philip Fisher. “This does not mean that a desirable company may not have a number of divisions, some of which have product lines quite different from others.”

3. How effective are the company’s research and development (R&D) efforts in relation to its size?

4. Does the company have an above-average sales organization?

5. Does the company have a worthwhile profit margin?

6. What is the company doing to maintain or improve profit margins?

7. Does the company have outstanding labor and personnel relations?

8. Does the company have outstanding executive relations?

9. Does the company have depth to its management?

10. How good are the company’s cost analysis and accounting controls? .

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

12. Does the company have a short-range or long-range outlook in regard to profits?

13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

14. Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

15. Does the company have a management of unquestionable integrity?

 

 

Who is Ray DeVoe?

The name Ray DeVoe was mentioned by Warren Buffett in his FY2010 letter to Berkshire Hathaway shareholders.

Warren Buffett said: “We keep our cash largely in U.S. Treasury bills and avoid other short-term securities yielding a few more basis points, a policy we adhered to long before the frailties of commercial paper and money market funds became apparent in September 2008.”

Then touching on a Ray DeVoe view, he said: ” We agree with investment writer Ray DeVoe’s observation, “More money has been lost reaching for yield than at the point of a gun.” At Berkshire, we don’t rely on bank lines, and we don’t enter into contracts that could require postings of collateral except for amounts that are tiny in relation to our liquid assets.””

So who is investment writer Ray DeVoe ?

According to an obituary, Ray DeVoe was Raymond F. DeVoe Jr (1929-2014). He died on Sept 27, 2014, at the age of 85.

A Sept 30, 2014, Bloomberg report (Raymond DeVoe Jr, Newsletter Writer for 35 Years, Dies) said: “In a Wall Street career dating to 1955, DeVoe was a voice for investors looking for long-term stakes in undervalued companies. He said in a 2011 interview with Bloomberg News that David Dodd, co-author with Benjamin Graham of the value investing classic “Securities Analysis” (1934),  “was my finance professor and guidance counselor” at Columbia University’s business school.”

The investment writer wrote the DeVoe Report, a financial newsletter, for 35 years.

Warning investors to beware “the dead cat bounce”, Roy DeVoe once said: “If  you threw a dead cat off a 50-story building, it might bounce when it hit the sidewalk. But don’t confuse that bounce with renewed life. It is still a dead cat.”

Investopedia describes the dead cat bounce as “a temporary recovery from a prolonged decline or a bear market that is followed by the continuation of the downtrend”. 

The Fourth Law of Motion that Sir Isaac Newton failed to discover

“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius,” Warren Buffett  said in a comment in Berkshire Hathaway’s FY2016 annual report.

” But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.”

“If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”

To understand better why Sir Isaac Newton said “I can calculate the movement of the starts, but not the madness of men”,  read Buffettpedia’s post “Are you an intelligent investor?”.

Warren Buffett is set to win this US$500,000 wager

Background on Warren Buffett’s US$500,000 wager: Warren Buffett said in  Berkshire’s 2005 annual report that  active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still.

Recalling his argument, he said in his FY2016 letter to Berkshire Hathaway shareholders: “I explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund. ..

“Subsequently, I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?
Mr Buffett went on to say: “What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides – stepped up to my challenge. Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds – in other words, a fund that invests in multiple hedge funds.

“I hadn’t known Ted before our wager, but I like him and admire his willingness to put his money where his mouth was. He has been both straight-forward with me and meticulous in supplying all the data that both he and I have needed to monitor the bet.

“For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager.
Each fund-of-funds, of course, operated with a layer of fees that sat above the fees charged by the hedge funds in which it had invested. In this doubling-up arrangement, the larger fees were levied by the underlying hedge funds; each of the fund-of-funds imposed an additional fee for its presumed skills in selecting hedge-fund managers.
“Here are the results for the first nine years of the bet – figures leaving no doubt that Girls Inc. of Omaha, the charitable beneficiary I designated to get any bet winnings I earned, will be the organization eagerly opening the mail next January.
“The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time. That’s an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large “short” positions. Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds.

“Instead we operated in what I would call a “neutral” environment. In it, the five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000….”

Mr Buffett summed it up this way: “So that was my argument – and now let me put it into a simple equation. If Group A (active investors) and Group B (do-nothing investors) comprise the total investing universe, and B is destined to achieve average results before costs, so, too, must A. Whichever group has the lower costs will win…”

” The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane – a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul – said it well: “In investment management, the progression is from the innovators to the imitators to the swarming incompetents”,” Mr Buffett said.

Mr Buffett’s bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.

Warren Buffett graces Cherry Coke cans

“It should come as no surprise that iconic investor Warren Buffett is one of the world’s best-known fans of Cherry Coca-Cola. At almost every public appearance for a generation, Buffett has been seen taking a swig of his favorite drink,” says a March 31, 2017 article (Chinese Consumers Do a Double-Take as Warren Buffett Graces Cherry Coke Cans) on the Coca-Cola website.

“What may come as a surprise is that Buffett’s likeness is gracing the front of Cherry Coke cans in China to promote the drink’s official Chinese launch.” said the article.

The article reminds one of Warren Buffett’s love for the Coke company. Berkshire Hathaway, of which Warren Buffett is the chairman, has a stake of 9.3 per cent in The Coca-Cola Company based on the FY2016 letter which Warren Buffett sent to Berkshire Hathaway shareholders.

An April 24, 2013 article ( ‘I Like to Bet on Sure Things’: Warren Buffett On Why He’ll Never Sell a Share of Coke Stock ) on the Coca-Cola website quoted Warren Buffett on why KO (Coca-Cola Company) will always have a “Buy” rating in his book.

“I’m the kind of guy who likes to bet on sure things,” said Buffett, who served on Coke’s board of directors for 17 years. “No business has ever failed with happy customers… and you’re selling happiness,” said Warren Buffett.

“I like wonderful brands,” he added. “If you take care of a great brand, it’s forever.”

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