Is Buffett's purchase into Goldmans really just insurance?

Much has been said and made about Warren Buffett's $5 Billion purchase into Goldman Sachs.

There's no doubt that Mr. Buffett is a very cagey investor, having waited until Goldman was (effectively) permitted to turn itself into a commercial bank. This lowered the risk of Goldman Sachs measurably, since they can now step up to the Fed and secure further funding, making the risk of failure fade considerably.

That he bought into an investment now that competitive forces have been considerably reduced should surprise no one, given Mr. Buffett's oft-stated opinion that he likes businesses with "pricing power". If a passel full of your competitors just bit the dust, or found themselves in the arms of a much more conservative commercial lending culture this, as an owner, can only have you rubbing your hands with pleasure.

Of course, you can't ignore the fact that he invested in what amounts to convertible preferreds (at WB's option effectively), happily collecting his 10% interest along the way. He's, as always, limiting his downside, while maximizing his upside.

But my final thought about this purchase is this: Mr. Buffett would happily see lower prices for some indeterminate period of time, but a financial melt-down wouldn't be in his interest, no matter how low the prices got.

Aside from his strong humanist streak (making him well aware of the human suffering that would cause), he's well aware of how long markets can potentially take to recover lost ground. In the case of the US and the Great Depression, the Dow Jones did not surpass the 1929 heights until 1954. Yes, 1954. One can only look at Japan today to see a similar market (if not Main Street) phenomenon in play.

So, I wonder whether, knowing that a more orderly decline of the stock market can play just as well - and probably better - into his hands, he stepped up with this purchase. A purchase, with his reputation, large enough to salve the panic-stricken, and yet with many of his classic down-side protection hallmarks. As a percentage of his total portfolio, and even of his cash holdings, $5 billion represents a small fraction of Berkshire's total assets.

I wonder if, in effect, Warren Buffett wrote a very large, very public, insurance policy against a disorderly market decline? An insurance policy that effectively rests upon his reputation, more than anything else?


JW

The Confused Capitalist

Betcha a $Billion or two ... Warren Buffett buys more bank stock

Filings covering the period ending September 30 2007 showed that Berkshire Hathaway added to stakes in three large U.S. banks with increased stakes in Wells Fargo & Co (NYSE:WFC), U.S. Bancorp (NYSE:USB) and Bank of America Corp (NYSE:BAC).

Between then and now, prices in two of those three banks fell by around 10% at one point or another, while stock in US Bancorp was available at around the same price as its lowest price in the quarter ending Spetember 30th.

Given Mr. Buffett's well-known penchant for buying discounted, out-of-favour stocks, do you think his next filing will show he added to those positions with his ~$40 Billion cash hoard?

Betcha a billion or two he did.

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JW

The Confused Capitalist

Sectors Still Look Poised for Outperformance

Back in August, right near the bottom of the mini-plunge, I suggested several sectors whose stocks looked poised for outperformance over the longer term, as well as a couple of groups to avoid.

The groups I liked included some of the bigger banks (although I warned that further declines of 10-20% also looked possible), whose yields were then in the 3.4% to 5.0% range or so.

They also included some of the large engineering firms, who I see as prime beneficiaries of the design and oversight work needed to build out the emerging markets infrastructure, and the work needed to replace the aging infrastructure of the western world.

It also included several emerging markets suggestions, and a later posting suggested that distressed credit buyers would have the opportunity to load up their balance sheets with cheap debt, which could fuel earnings for years to come.

Since those predictions, the S&P 500 has bounced up and then down, and is essentially flat over that period.

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The banks mentioned have generally declined, most by about 10-20%, but with Citigroup getting trashed. On the other hand, some have held up pretty well, considering the magnitude of write-offs announced since then. I still like them, and now most of the yields are now in the 5-7% range, making them even more attractive in the face of what I see as a weak market. Maybe it's just me and Warren Buffett who like the bank stocks at these prices.

Engineering firms still look good as a look term-prospect, but this may be somewhat tempered by the fact that most of those discussed have moved sharply upwards, by 10-50% since then.

The emerging markets suggestions have also moved up, by about 15-20% on average of the group discussed.

Finally, a later August 2007 suggestion of looking at some distressed credit buyers is essentially flat as a group.

I still like all of these groups, and think that current prices are likely to look good several years from now.




JW

The Confused Capitalist

Are Growth Stock Prices Reflecting a Cheery Consensus?

In one of his chairman's letters, Warren Buffett once stated that ...

"The future is never clear, you pay a very high price in the stock market for a cheery consensus."

I just looked at the 10 year returns of the Russell 1000 Value Index, and the Russell 1000 Growth Index.

Frightening, the cost of a cheery consensus, particularly those orienting towards the growth side of the equation.

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The difference in the current valuation metrics on the two indices are significant, scary, and points to, may I suggest, more of the same looking forward.



JW

The Confused Capitalist

Do it yourself stock investing is extraordinarily difficult because ...

... because the knowledge base required is fairly extensive, complicated and mostly because the feedback loop takes a long time to complete.

As peoples barely removed from the hunter-gather stage of development, as investors we are still barely above our fight or flight method of handling things. Fight or flight is a fabulous mechanism when being chased down by a lion, but not all that great for quelling an emotional response to a stock market beating.

So, while we think we've done a good job analyzing an investment and weighting the odds of success in our favor (both by the investment itself, and by the relative weighting of that investment in our portfolio), we don't have a whole lot more to go on for some period of time. As superinvestor Warren Buffett has frequently noted, over the short term the stock market is an emotion measuring machine, but over the long term it is a weighing machine.

However, we're always looking for the constant feedback that tells us if we're doing something right or wrong. In sports, like soccer, we get very good immediate feedback. If we keep getting beat to the inside by a striker, we learn to back up more, or take better body positioning. After a couple of games and practices, we find it's not happening so frequently.

In investing however, we look for immediate feedback and validation that we've made a correction (or incorrect) choice from the market. Unfortunately, proper market feedback (i.e. the weighing machine, not the emotion machine) often takes several years to materialize. In the interim, we have turned to the measure of observing the daily (hourly?) price change of our securities to provide the feedback loop we desire.

But we really know that this isn't going to work too well. My suggestion would be to turn off your computer and re-visit your holdings every quarter or so. Benchmark it against a comparable investment set. Then give yourself some feedback.

I fully intend to do just this ... but I just need to check my holdings just once more ... or so ...


JW

The Confused Capitalist

Corporate Reason in the Age of Analysts

Brilliance is sometimes simply being willing to say the obvious and to stick with it. On the one hand, we have the myopic analysts, and on the other, we have a few select folks like superinvestor Warren Buffett and company.

Contrast the rationale of analysts found in the prior link, with the recent words (2005 Chairman's letter) of Warren Buffett:

"Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as '“widening the moat.' And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted.

Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin's 'An ounce of prevention is worth a pound of cure.'

But sometimes no amount of cure will overcome the mistakes of the past."

Something to think about the next time you're pondering an investment ...


JW

The Confused Capitalist

A Business that Uncle Warren would just love!

Found: an IPO that "Uncle Warren" would just love (at the right price of course!)

Canada's most-populous province, Ontario has announced that they will be selling off their interest in the electronic provincial land titles registry, Teranet. Teranet, partially owned by Teramira Holdings Inc., is reportedly ready to push out its prospectus this week, which should be available on Sedar (Canadian equivalent to Edgar), very soon. It is reportedly to be structured in a Canadian income trust format, which eliminates or minimizes corporate taxes. Income trusts have become a favorite of Canadians and Canadian companies over the past few years, with many former corporate entities converting to an income trust.

Teranet is the kind of business that Warren Buffett would just love, since they hold a monopoly on the registration of land title transactions that go on in the province. Just the kind of toll booth that Warren loves.

Teranet charges fees ranging from $18 for an electronic search, to $70 to register a mortgage document. It currently has 750 employees. In 2003, the last year that its operational results were made public, it sported an operating profit for $118 million on revenues of $190 million. Last December, Standard and Poors raised its credit rating to double-A, and noted that $100 million had been taken out of the company during the past year. If Ontario continues growing at the rate demonstrated over the latest available five census years (1996-2001), at about 1.2% annually, combined with revenue increases at or above the rate of inflation, this is a very nice-looking business indeed.

RBC Dominion Securities is leading the offering, and initial reports state that shares are expected to be priced at $10 (CDN) per share level, with initial annual cash distributions projected in the $0.70 to $0.80 range, thus yielding 7-8%. If this is actually the case, I would expect that yields will show a quick decline to the 5% to 6.5% range, as the secondary market quickly reprices the shares to reflect the relative safety and security of this offering. (For comparison purposes, the Yellow Pages Income Trust - probably a lower quality business - sports a 6.4% yield currently).

Over the long haul, given that all land titles have to be registered here, the business looks like a great medium to long-term situation, that should offer the opportunity for above-average returns.

Monopolies: Businesses that Uncle Warren just loves. Maybe you should too!


JW

The Confused Capitalist

Berkshire Hathaway: Law of Large Numbers Catching Up

Superinvestor Warren Buffett's company, Berkshire Hathaway, recently announced a 54% increase in quarterly earnings, and a 16% increase year over year. Performance like this has led Berkshire's shares to attain lofty prices, and to continue to outpace the broader market, year after year.

However, just like the mouse on the left would have more trouble gaining 10% of its weight than the mouse on the right, Berkshire is - as Mr. Buffett has repeatedly warned - going to have trouble continuing to outpace the S&P500 as the company becomes larger and larger.

In fact, more and more of Mr. Buffett's acquisitions take him farther and farther from his preferred investments - such as insurance companies and banks, and companies that commend "top of mind" presence with the element of repeated purchase present (i.e. think Coca-Cola, a major holding of Berkshire). Some recent acquisitions include home builders and RV makers. These obviously don't fit that profile and tend to be more in commodity-oriented type venues, where price becomes a larger factor than prestige or habit.

In fact, just as Mr. Buffett warned, his marked outperformance vs. the S&P500 is clearly waning. The following info is taken from the Berkshire web-site and shows his average annual outperformance of internal book value vs. the S&P500 by decade:

• 1970s - 15.8% better per annum
• 1980s - 11.4% better per annum
• 1990s - 6.3% better per annum
• last ten years - 5.6% better per annum

This isn't to say that Berkshire shares don't still represent an above-average investment and probably offer better value than the standard mutual fund - just that the outperformance going forward is unlikely to match that of the past. In fact, in three of the most recent seven years, Berkshire's increase in book value per share, didn't meet the return of the S&P500 - an unprecedented result!

Nevertheless, Mr. Buffett has a remarkable record of outperformance, and that outperformance - albeit by a diminishing margin - may very well stay intact for many years into the future.

You can buy one share of Berkshire Hathaway "A" series (BRK-A) for a cool $87,400, or one of the "B" series (1/30 economic value) for $2,911 (BRK-B).


JW

The Confused Capitalist