Monthly Archives: January 2011

Links of Interest – January 28, 2011

Nokia Net Falls, CEO Hints of Strategy Change – WSJ.com – stimulating article for thinking about the importance moats

In the Long Run, Apple Will ‘Bow To Android Reality’ – Deal Journal – WSJ

BYD Founder Offers Details on Dealer-Friendly Plans – China Real Time Report – WSJ

Buy Johnson & Johnson’s Stock on Earnings Weakness – Barrons.com

The Callie Crossley Show – details the importance of adequate sleep for solving complex problems and general well-being

An enriching strategy for quality assets – Francois Rochon of Giverny Capital

Buy Johnson & Johnson’s Stock on Earnings Weakness – Barrons.com

Berkshire Hathaway looks cheap based on its cash-adjusted price to “look-through” earnings ratio

Buffett has always viewed GAAP accounting as a starting point for understanding the economics of a business. Years ago, in this regard, he introduced the idea of “look-through” earnings. The idea is that Berkshire’s share of unreported earnings – primarily those generated and retained by businesses in its sizable equity portfolio – are just as valuable as the earnings it does report under GAAP.

Here’s what Buffett said about the matter in his 1989 letter to shareholders:

In our view, Berkshire’s fundamental earning power is best measured by a “look-through” approach, in which we append our share of the operating earnings retained by our investees to our own reported operating earnings, excluding capital gains in both instances.

And here’s more on the subject from the Berkshire Hathaway Owner’s Manual:

Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains.

We have found over time that the undistributed earnings of our investees, in aggregate, have been fully as beneficial to Berkshire as if they had been distributed to us (and therefore had been included in the earnings we officially report). This pleasant result has occurred because most of our investees are engaged in truly outstanding businesses that can often employ incremental capital to great advantage, either by putting it to work in their businesses or by repurchasing their shares. Obviously, every capital decision that our investees have made has not benefitted us as shareholders, but overall we have garnered far more than a dollar of value for each dollar they have retained. We consequently regard look-through earnings as realistically portraying our yearly gain from operations.

As I wrote about a couple of days ago, Barron’s in its January 22, 2011 article on Buffett and Berkshire Hathaway entitled “Mr. Moneybags” states that Berkshire’s 2011 earnings are, “On track to hit a record $12 billion to $13 billion after taxes.” That would be $7,500 to $8,000 per share in 2011.

However, because this figure excludes “look-through” earnings, it materially understates Berkshire’s true economic earnings. By my rough calculation based on consensus 2011 analyst estimates, Berkshire will earn an additional $1,680 per share from its share of the earnings of its equity holdings net of dividends. In the past and I assume to be conservative, Buffett also subtracted taxes from the look-through earnings as if they were paid out as dividends. I did not do this as no taxes are actually assessed and given Berkshire’s history of low turnover.

Here is my data.

That means Berkshire’s look-through earnings are on track to be between approximately $9,200 and $9,700 for 2011.  Given its current share price of approximately $124,000 per A share and that Barron’s reasonably projects it will have approximately $30,000 a share in cash at the end of 2011 (or $50,000 billion), Berkshire is currently selling at only about 10 times it cash-adjusted 2011 earnings. Using a market multiple of 15 times earnings would imply that Berkshire Hathaway is worth approximately $170,000 per share.

That’s pretty cheap for a basket of world-class companies that were hand-picked by Warren Buffett and which enjoy a formidable collection of incentivized, proven, entrepreneurial, owner-oriented mangers.

Heads I win, tails I win

Barron’s article over the weekend on Berkshire Hathaway, “Mr. Moneybags”, highlighted the enormous earnings power of Berkshire Hathaway. According to the article, Berkshire could earn between $12 billion and $13 billion in profits in 2011 and could end the year with as much as $50 billion in cash. The stock looks attractive at a projected 1.15x projected 2011 year-end book value.

As optimism begins to return to the stock market, many investors will once again become infected by greed and increasingly lose sight of the very real risks of coming late to the party by buying or holding overvalued stocks.

In contrast, the article pointed out that Berkshire Hathaway’s attractive valuation provides “significant downside support”.

I’d also like to point out one other fairly obvious advantage of owning Berkshire Hathaway. If the economy continues to improve and stabilize, Berkshire’s wonderful collection of businesses will shine and the stock will – over time – reflect its vast, growing stream of earnings, regardless of what sell-side analysts are saying. In the long-term, the market is indeed a weighing machine.

On the other hand, Berkshire is very well positioned if the market were to undergo a major correction in the short-term to medium-term.

At the 1994 Berkshire Hathaway annual meeting, Buffett pointed out that the best thing for Berkshire Hathaway was for the market to go down a “tremendous” amount – although he was not predicting it and he was clear to point out that he was not wishing for such a thing to happen. That way, stocks and businesses would become cheaper, and Buffett would be able to put Berkshire’s cash to optimum use. (1)

Buffett said we should fear a sustained irrational bull market because attractive purchases would likely dry up. Given what we have been through, that’s a problem I’m prepared to live with. If, however, the market goes down, Berkshire shareholders have the advantage of a huge amount of cash and Buffett’s incomparable investing talents. That’s a bet I’m comfortable taking.

(1) Outstanding Investor Digest, June 23, 1994, p. 20.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.

Links of Interest – January 21, 2011

Buffett Stock Picker Simpson Opens Florida Firm After Retiring From Geico – Bloomberg

FT.com / Comment / Opinion – America must brace itself for turbulence

Worthless Stocks from China – BusinessWeek

In Race to Market, It Pays to Be Latecomer – WSJ.com

Top Performer Winters Sees Stocks Rising to Record on Government Stimulus – Bloomberg

David Einhorn & Greenlight Capital’s 2010 Year-End Letter – Courtesy of Marketfolly.com


Greenlight-Q4-2010

Planck knowledge vs Chauffeur knowledge

“After winning the Nobel Prize, Planck toured around giving a speech. The chauffeur memorized the speech and asked if he could give it for him, pretending to be Planck, in Munich and Planck would pretend to be the chauffeur. Planck let him do it and after the speech someone asked a tough question. The real chauffeur said that he couldn’t believe someone in such an advanced city like Munich would ask such an elementary question and as such, he was going to ask his chauffeur (Planck) to reply].

In this world we have two kinds of knowledge. One is Planck knowledge,the people who really know. They’ve paid the dues, they have the aptitude. And then we’ve got chauffeur knowledge. They have learned the talk. They may have a big head of hair, they may have fine temper in the voice, they’ll make a hell of an impression. But in the end, all they have is chauffeur knowledge

Source: Charlie Munger – USC School of Law Commencement – May 13, 2007

The internet is filled with opinions and superficial analyses that are an inch deep and a mile wide. A steady diet of this can lead to a lot of chauffeur knowledge. Couple this with over-confidence bias and you have the recipe for lousy returns at best and permanent loss of capital at worst.

Don’t succumb to this tendency. Spend the majority of your time reading source documents and forming your own opinions, and stay within your circle of competence – even if it is quite small. Rose Blumpkin got very rich focusing on one tightly defined retail niche. There are no short cuts to Plank knowledge, but that is where the money is.

Links of Interest – January 17, 2011

Buffett’s Buddy Charlie Munger to Goldbugs: ‘You’re a Jerk.’ – MarketBeat – WSJ

Simoleon Sense » Blog Archive » Miguel Barbosa Interviews Joe Calandro, JR. Author of Applied Value Investing

The Ideas Report For Serious Investors: Guy Spier on Navigating Between Fear and Greed Using Investment Checklists — Live Blogging the Value Investing Seminar, Italy

David Einhorn & Greenlight Re – Fundmastery Blog – MarketWatch

How to Become a Great Investor — The Graham Investor

Buffett-Backed BYD Tries to Get Back on Track – WSJ.com

Video: BYD Exec Reveals U.S. Strategy – China Real Time Report – WSJ

Links of Interest – January 7, 2011

Comments on The internet: How long will Google’s magic last? | The Economist

Warren Buffett Speaks Candidly to Vanity Fair About Who Might Succeed Him at Berkshire Hathaway | VF Daily | Vanity Fair

Valuation of Berkshire Hathaway – http://www.tilsonfunds.com/BRK.pdf

Donald Yacktman Interview on Stock Strategy, Dec. 29 – Video – Bloomberg

Why You Should Buy Large Cap Multinationals – Seeking Alpha

Ruane, Cunniff & Goldfarb Investor Day – May 14, 2010

“We don’t back into decisions.”

Once we knew that the General Re merger would definitely take place, we asked the company to dispose of the equities that it held.  (As mentioned earlier, we do not manage the Cologne Re portfolio, which includes many equities.)  General Re subsequently eliminated its positions in about 250 common stocks, incurring $935 million of taxes in the process.  This “clean sweep” approach reflects a basic principle that Charlie and I employ in business and investing: We don’t back into decisions. – Warren Buffett, Berkshire Hathaway 1998 Shareholder Letter

The new year is a time of reflection which generally focuses on how we can improve ourselves. A basic tenet of intelligent investing is to understand what you own and why you own it. This does not mean that you won’t make mistakes, but it does mean that, if something doesn’t work, you should be able to identify where your analysis went wrong – and learn from it going forward. Now is a great time to look at your portfolio and determine if you have holdings that don’t meet this simple test. Maybe you have some stocks that you bought without doing your homework or that are holdovers from a prior financial advisor. Whatever the case, if you don’t understand these businesses and why they are intelligent investments, maybe you should consider Buffett’s philosophy and take a “clean sweep” approach with those holdings.

Happy New Year to all the readers of my blog. I wish you all the best in 2011!