Berkshire Hathaway

Few highlights from Berkshire Hathaway’s 2007 annual report.

Charlie and I look for companies that have:

• a business we understand
• favorable long-term economics
• able and trustworthy management; and
• a sensible price tag.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital.

But if a business requires a superstar to produce great results, the business itself cannot be deemed great.

There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so.

[Talking about investments in different types of companies] To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

[On buying Dexter, a shoe business with Berkshire stock] In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.

[On buying Amazon bonds at 57% of par] Yes, Virginia, you can occasionally find markets that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.

Centaur Capital Partners - How Concentrated Should You Be

Value Investing News highlighted this presentation (pdf) from Centaur Capital Partners about how concentrated an investment portfolio should be.

A few quotes from the presentation:

Not every idea has to be worthy of a very large position allocation to be included in our portfolio so long as each idea adds an unique element that contributes something to the favourable asymmetric payoff profile for the portfolio as a whole.

Value comes in many forms, including:

• Out-of-favor blue chips
• Stubs
• Out-of-favor cyclicals
• Net-nets
• Distressed industries
• Discounts to cash
• Turnarounds
• Declining cash cows
• Overlooked small caps
• Oddball companies
• Fallen growth angels
• Sum-of-the-parts
• GARP (growth at reasonable price)
• Activist opportunities
• Spin-offs
• Post-bankruptcies

There are several common “portfolio models” used by successful value investors that we have come across:

• Ultra-concentrated portfolio model
  • Fewer than 10 stocks with large position sizes routinely comprising 20-25% of portfolio assets and larger.
  • Practitioners: Chieftain, Eddie Lampert, Tom Brown.
• The 10 stock model
  • Standard position size of around 10%, though there may be one or two larger positions, and a handful of smaller positions for a total of 12-20 ideas.
  • Practitioners: Mohnish Pabrai, Clipper.
• Standard 20-stock model
  • Standard position size for a good idea is about 5%, though best 2-3 ideas may be modestly larger and many ideas are somewhat smaller. Total portfolio of 25-40 ideas.
  • Practitioners: Many of the value mutual fund managers on the previous slide: Robert Hagstrom, Bill Miller, Wally Weitz, Longleaf Partner, Tweedy Brown Value, etc.
• 20-stock model (super-sized)
  • Essentially the same as standard 20-stock model, but two or three best ideas are “super-sized” to 10-15% of the portfolio, and there are fewer sub-5% positions. Total of 20-30 ideas.
  • Practitioners: Tilson Focus, Fairholme, Sequoia, Oakmark Select.

 “Confronted with the challenge to distil the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” Benjamin Graham, Intelligent Investor.

Why is having a margin of safety important?

• Valuation is an imprecise art.
• The future is inherently unpredictable.
• Having a margin of safety provides protection against bad luck, bad timing, or error in judgment.

Whitney Tilson’s 2007 Wesco Annual Meeting Notes

Value Investing News has a link to Whitney Tilson’s 2007 Wesco annual meeting notes (pdf). They make for good reading. Charile Munger is Chairman of Wesco.

Some selected quotes from the meeting are below:

If you really want a lot of wisdom, it’s better to concentrate decisions and process in one person.

I talked to a leading person in the accounting field and said it didn’t make sense to let companies mark weird stuff to their own models – that it would lead to disaster. She looked at me like I was out of my mind and asked, “Aren’t you for the most current data in accounting? My system is more current and therefore should be better.” This mind would score highly on an IQ test, but is scarcely able to throw out the garbage.

If you’re really wise and fortunate, you get to be like Berkshire. We have high opportunity costs. We always have something we like and can buy more of, so that’s what we compare everything to.

Cheap Financials

The FT has an article about how cheap financial shares are at the moment. Which reminded me about Ariel Funds recent letter to investors, in which they outline why UBS is a good investment.

Ariel Funds estimates UBS’ intrinsic value to be US$94 compared to their purchase price of US$60 and today’s price of US$52.

You can check out more of John Roger’s (founder of Ariel Funds) current investments on Gurufocus.

You Can Be a Stock Market Genius

I have finished reading Joel Greenblatt’s book - You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits. Which I highly recommend.

The main points I got out of the book are:

• Spin-offs are an attractive area to invest in. Investors that receive shares in a spin-off normally do not want to hold them and sell soon after the spin-off. For example an institutional investor may not even be allowed to hold shares below a certain market cap or outside of the S&P500.
  • Look for institutional investors that do not want the shares and will sell them immediately, depressing the price.
  • Insiders want to buy the shares, look for management making an investment.
  • The transaction may unlock hidden value, the business may be able to operate more efficiently after being spun-off from the parent company.
• Holding companies can offer good opportunities. For example a company that holds some listed shares, might trade at a discount. Or at the same value, letting you buy the core business for close to zero.
• Merger securities. Can offer investment opportunities for the same reason as spin-offs. The people receiving the securities do not want them, so look to sell them straight away. Plus always look at the details in the SEC filings.
• Companies coming out of bankruptcy. These may not be looked at by other investors due to lack of coverage or unwillingness to invest in a company that has been bankrupt.
• LEAP options can offer extra upside for investments.
• Options can be useful when investing in spin-off opportunities. Any option that can be exercised after the spin-off entitles the holder to receive a share in both the parent and the spin-off.
• Steal other people’s ideas. Read investment newsletters, read other investors’ annual reports and announcements.

The book has a number of case studies which are useful in understanding each of the concepts and showing that they really do work (or have worked in the past).

Ben Graham’s Principles

Summary of Ben Graham’s principles from Oak Value shareholder letter (pdf).

• Investing is most intelligent when it is business-like. Very simply, we view this principle as suggesting that one should view investments in public companies in the same manner that they could if they were going to buy the entire business.
• Always require a “margin of safety”. We define “margin of safety” as a discount to our
  estimate of a company’s intrinsic value sufficient to compensate us as investors for the risks and uncertainties assumed and the capital allocated.
• Maintain the appropriate perspective. Recognize that the market is a mechanism; a vehicle there to facilitate what we might wish to do as investors, but it does not require that we do anything.

Fund Manager Picks

Here is a summary of specific businesses mentioned in recent shareholder letters by fund managers from my previous post.

Oakmark

• Sprint-Nextel

Ariel

• Mohawk
• Johnson & Johnson - they have an intrinsic value estimate for the shareprice of $105.
• USG
• Dell
• Berkshire Hathaway

Oak Value

• Aon
• 3M
• Microsoft
• Berkshire Hathaway

Selected Funds

• Sprint-Nextel
• Appollo

Longleaf Partners

• Dell
• Aon

Wallace R. Weitz & Company (Value and Partners Value funds)

• Appollo
• Dell
• Mohawk
• USG

Shareholder Letters

Shareholder letters can be a great source of investment ideas and about investment thinking. Berkshire Hathaway’s shareholder letters get coverage every year, but there are many other fund mangers with valuable advice.

Morningstar has put together this list. The full article has comments about each manager.

• Ariel Funds
• Baron Funds
• Berkshire Hathaway
• Clipper Fund
• FPA Capital
• Gabelli Funds
• Legg Mason Value Trust
• Longleaf Partners
• Oakmark
• Oak Value
• Olstein Financial Alert
• Selected American
• Sequoia Fund
• Third Avenue Value
• Torray
• Tweedy, Browne
• Weitz
• Wesco Financial