A follow-up to this post on Berkshire Hathaway's (BRKa) textile business. From the 1985 shareholder letter:
For an understanding of how the to-invest-or-not-to-invest dilemma plays out in a commodity business, it is instructive to look at Burlington Industries, by far the largest U.S. textile company both 21 years ago and now. In 1964 Burlington had sales of $1.2 billion against our $50 million. It had strengths in both distribution and production that we could never hope to match and also, of course, had an earnings record far superior to ours. Its stock sold at 60 at the end of 1964; ours was 13.
Burlington made a decision to stick to the textile business, and in 1985 had sales of about $2.8 billion. During the 1964-85 period, the company made capital expenditures of about $3 billion, far more than any other U.S. textile company and more than $200-per-share on that $60 stock. A very large part of the expenditures, I am sure, was devoted to cost improvement and expansion. Given Burlington's basic commitment to stay in textiles, I would also surmise that the company’s capital decisions were quite rational.
Nevertheless, Burlington has lost sales volume in real dollars and has far lower returns on sales and equity now than 20 years ago. Split 2-for-1 in 1965, the stock now sells at 34 -- on an adjusted basis, just a little over its $60 price in 1964. Meanwhile, the CPI has more than tripled. Therefore, each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends have been paid but they, too, have shrunk significantly in purchasing power.
This devastating outcome for the shareholders indicates what can happen when much brain power and energy are applied to a faulty premise. The situation is suggestive of Samuel Johnson's horse: "A horse that can count to ten is a remarkable horse - not a remarkable mathematician." Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company - but not a remarkable business.
My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row...
Then later in the letter Buffett added...
Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.
Since businesses with commodity-like economic characteristics by definition have little or no pricing power, a sustainable cost advantage ends up being the crucial factor for investors.
Now, it's one thing to understand the importance of owning shares of low cost producers (or, at the very least, among the lowest cost producers), but sometimes figuring out who that actually is and why the advantage they have is sustainable isn't all that easy.
Adam
Showing posts with label Berkshire Shareholder Letter Highlights: 1977-86. Show all posts
Showing posts with label Berkshire Shareholder Letter Highlights: 1977-86. Show all posts
Monday, April 16, 2012
Tuesday, April 10, 2012
Buffett on Commodity Businesses
...when a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. - Warren Buffett
From the 1985 Berkshire Hathaway (BRKa) Shareholder Letter:
Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: "All I want to know is where I'm going to die so I'll never go there." You'll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him, particularly in our textile and insurance businesses.
In the 1985 letter, the mistake Buffett focuses on is the one he made with Berkshire's textile operations.
Early on, the cash generated by the textile business had funded Berkshire's entry into insurance. It was a crucial move since the textile business never earned much even in a good year.
Smart capital allocation led to further diversification and, over time, the textile operation became a relatively small portion of Berkshire. Excess capital was consistently put to more attractive alternative uses. If that capital had been instead invested back into the textile operation Berkshire would be a shadow of itself.
In the 1978 letter, Buffett listed the four reasons why they were staying in the textile business despite its relatively unattractive economics. The last of the 4 reasons listed by Buffett was that:
...the business should average modest cash returns relative to investment.
He also said:
As long as these conditions prevail - and we expect that they will - we intend to continue to support our textile business despite more attractive alternative uses for capital.
By the mid-80s there was overwhelming evidence Buffett's thinking in 1978 was incorrect. For the most part, the textile business continued to be a consumer of cash. He admits as much in the 1985 letter saying:
It turned out that I was very wrong...Though 1979 was moderately profitable, the business thereafter consumed major amounts of cash. By mid-1985 it became clear, even to me, that this condition was almost sure to continue. Could we have found a buyer who would continue operations, I would have certainly preferred to sell the business rather than liquidate it, even if that meant somewhat lower proceeds for us. But the economics that were finally obvious to me were also obvious to others, and interest was nil.
I won't close down businesses of sub-normal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses in prospect. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second; the middle ground is the only position that leaves me comfortable.
So the textile business was largely shut down during 1985. Buffett later added...
Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on- investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses.
But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company's capital investment decision appeared cost- effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic.
Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital.
Unless a commodity business has a clear and sustainable built in cost advantage over competitors, capital expenditures will likely make little sense.*
Returns of these businesses, at least as a general rule, will be subpar.
The Appendix to the 1983 Berkshire Hathaway Shareholder Letter is relevant here. In it, Buffett explains economic Goodwill.**
It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Yet economic Goodwill can also exist in non-consumer businesses...
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry.
Otherwise, lacking a sustainable advantage, large amounts of capital investment aren't likely to work out well in the long-run for owners.
There are exceptions but most commodity businesses (excl. things like governmental franchises or a monopoly-like position) need to have a sustainable cost advantage to produce above average returns.
The lessons from Berkshire's textile business experience may be useful background for those considering an investment in a commodity-like business.
Adam
Buffett on Commodity Businesses - Part II
* Government interference can subsidize or support what otherwise is a commodity business. Well, at least enough help that there is less competition and no overbearing profit regulation. Eliminate the natural competing forces or provide subsidies and the underlying economics may no longer seem like that of a commodity business. Yet, if proper competition existed it would. In contrast, it is the reputation and brand of successful consumer franchises create their pricing power. No government support or monopoly required.
** Economic Goodwill is very different animal from accounting Goodwill. Buffett does a good job of describing the differences in the Appendix to the 1983 letter.
From the 1985 Berkshire Hathaway (BRKa) Shareholder Letter:
Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: "All I want to know is where I'm going to die so I'll never go there." You'll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him, particularly in our textile and insurance businesses.
In the 1985 letter, the mistake Buffett focuses on is the one he made with Berkshire's textile operations.
Early on, the cash generated by the textile business had funded Berkshire's entry into insurance. It was a crucial move since the textile business never earned much even in a good year.
Smart capital allocation led to further diversification and, over time, the textile operation became a relatively small portion of Berkshire. Excess capital was consistently put to more attractive alternative uses. If that capital had been instead invested back into the textile operation Berkshire would be a shadow of itself.
In the 1978 letter, Buffett listed the four reasons why they were staying in the textile business despite its relatively unattractive economics. The last of the 4 reasons listed by Buffett was that:
...the business should average modest cash returns relative to investment.
He also said:
As long as these conditions prevail - and we expect that they will - we intend to continue to support our textile business despite more attractive alternative uses for capital.
By the mid-80s there was overwhelming evidence Buffett's thinking in 1978 was incorrect. For the most part, the textile business continued to be a consumer of cash. He admits as much in the 1985 letter saying:
It turned out that I was very wrong...Though 1979 was moderately profitable, the business thereafter consumed major amounts of cash. By mid-1985 it became clear, even to me, that this condition was almost sure to continue. Could we have found a buyer who would continue operations, I would have certainly preferred to sell the business rather than liquidate it, even if that meant somewhat lower proceeds for us. But the economics that were finally obvious to me were also obvious to others, and interest was nil.
I won't close down businesses of sub-normal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses in prospect. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second; the middle ground is the only position that leaves me comfortable.
So the textile business was largely shut down during 1985. Buffett later added...
Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on- investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses.
But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company's capital investment decision appeared cost- effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic.
Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital.
Unless a commodity business has a clear and sustainable built in cost advantage over competitors, capital expenditures will likely make little sense.*
Returns of these businesses, at least as a general rule, will be subpar.
The Appendix to the 1983 Berkshire Hathaway Shareholder Letter is relevant here. In it, Buffett explains economic Goodwill.**
It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Yet economic Goodwill can also exist in non-consumer businesses...
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry.
Otherwise, lacking a sustainable advantage, large amounts of capital investment aren't likely to work out well in the long-run for owners.
There are exceptions but most commodity businesses (excl. things like governmental franchises or a monopoly-like position) need to have a sustainable cost advantage to produce above average returns.
The lessons from Berkshire's textile business experience may be useful background for those considering an investment in a commodity-like business.
Adam
Buffett on Commodity Businesses - Part II
* Government interference can subsidize or support what otherwise is a commodity business. Well, at least enough help that there is less competition and no overbearing profit regulation. Eliminate the natural competing forces or provide subsidies and the underlying economics may no longer seem like that of a commodity business. Yet, if proper competition existed it would. In contrast, it is the reputation and brand of successful consumer franchises create their pricing power. No government support or monopoly required.
** Economic Goodwill is very different animal from accounting Goodwill. Buffett does a good job of describing the differences in the Appendix to the 1983 letter.
Tuesday, April 3, 2012
Buffett on Berkshire's Earnings Mix: Operating Earnings Versus Gains from the Sale of Securities
Analyzing Berkshire Hathaway's (BRKa) earnings isn't always straightforward.
The year 1985 wasn't especially confusing compared to other years but serves as a useful example. The Shareholder Letter from that year shows that Berkshire's pre-tax earnings grew substantially year over year from $ 200.5 million to $ 613.4 million.
On the surface a great year but, unfortunately, that bottom line number doesn't reveal much about what Berkshire's true earnings power was at the time.
It was, in fact, a very good year but not nearly as good as the tripling would indicate.
The reason? Much of the increase came from the sale of marketable securities. Here's how the picture looked that year with gains from the sale of securities separated from the earnings (in millions) from Berkshire's operating businesses:*
1984 1985
Operating earnings $ 87.7 $125.4
Gain from Sale of Securities $104.7 $468.9
Other $ 8.1 $ 19.0
Total Earnings $200.5 $613.4
Here's how Buffett explained the year over year performance in the 1985 Shareholder Letter:
Our 1985 results include unusually large earnings from the sale of securities. This fact, in itself, does not mean that we had a particularly good year (though, of course, we did). Security profits in a given year bear similarities to a college graduation ceremony in which the knowledge gained over four years is recognized on a day when nothing further is learned. We may hold a stock for a decade or more, and during that period it may grow quite consistently in both business and market value. In the year in which we finally sell it there may be no increase in value, or there may even be a decrease. But all growth in value since purchase will be reflected in the accounting earnings of the year of sale. (If the stock owned is in our insurance subsidiaries, however, any gain or loss in market value will be reflected in net worth annually.) Thus, reported capital gains or losses in any given year are meaningless as a measure of how well we have done in the current year.
The bulk of that gain from sale of securities was the result of selling General Foods.
Now, Berkshire had bought General Foods at what they viewed to be a substantial discount to per share business value back in 1980. Also, the business had fine underlying economics and, according to Buffett, a management that was focused on increasing that business value.
Shares bought cheap compared to 1980 value and, as a result of attractive underlying economics along with sound management, intrinsic value grew substantially over the five years or so.
None of the above led to a reported gain while the next thing that happened did. Philip Morris came along and made a nice premium buyout offer for the shares of General Foods. More from the letter:
We thus benefited from four factors: a bargain purchase price, a business with fine underlying economics, an able management concentrating on the interests of shareholders, and a buyer willing to pay full business value. While that last factor is the only one that produces reported earnings, we consider identification of the first three to be the key to building value for Berkshire shareholders. In selecting common stocks, we devote our attention to attractive purchases, not to the possibility of attractive sales.
So value was enhanced over many years but the gains had to be recognized all at once as accounting earnings in that one year.
Adam
* Earnings do not include the amortization of Goodwill. From the letter: ...amortization of Goodwill is not charged against the specific businesses but, for reasons outlined in the Appendix to my letter in the 1983 annual report, is aggregated as a separate item. The reason comes down to the difference between economic and accounting Goodwill. The Appendix in the 1983 letter does a nice job of explaining this.
The year 1985 wasn't especially confusing compared to other years but serves as a useful example. The Shareholder Letter from that year shows that Berkshire's pre-tax earnings grew substantially year over year from $ 200.5 million to $ 613.4 million.
On the surface a great year but, unfortunately, that bottom line number doesn't reveal much about what Berkshire's true earnings power was at the time.
It was, in fact, a very good year but not nearly as good as the tripling would indicate.
The reason? Much of the increase came from the sale of marketable securities. Here's how the picture looked that year with gains from the sale of securities separated from the earnings (in millions) from Berkshire's operating businesses:*
1984 1985
Operating earnings $ 87.7 $125.4
Gain from Sale of Securities $104.7 $468.9
Other $ 8.1 $ 19.0
Total Earnings $200.5 $613.4
Here's how Buffett explained the year over year performance in the 1985 Shareholder Letter:
Our 1985 results include unusually large earnings from the sale of securities. This fact, in itself, does not mean that we had a particularly good year (though, of course, we did). Security profits in a given year bear similarities to a college graduation ceremony in which the knowledge gained over four years is recognized on a day when nothing further is learned. We may hold a stock for a decade or more, and during that period it may grow quite consistently in both business and market value. In the year in which we finally sell it there may be no increase in value, or there may even be a decrease. But all growth in value since purchase will be reflected in the accounting earnings of the year of sale. (If the stock owned is in our insurance subsidiaries, however, any gain or loss in market value will be reflected in net worth annually.) Thus, reported capital gains or losses in any given year are meaningless as a measure of how well we have done in the current year.
The bulk of that gain from sale of securities was the result of selling General Foods.
Now, Berkshire had bought General Foods at what they viewed to be a substantial discount to per share business value back in 1980. Also, the business had fine underlying economics and, according to Buffett, a management that was focused on increasing that business value.
Shares bought cheap compared to 1980 value and, as a result of attractive underlying economics along with sound management, intrinsic value grew substantially over the five years or so.
None of the above led to a reported gain while the next thing that happened did. Philip Morris came along and made a nice premium buyout offer for the shares of General Foods. More from the letter:
We thus benefited from four factors: a bargain purchase price, a business with fine underlying economics, an able management concentrating on the interests of shareholders, and a buyer willing to pay full business value. While that last factor is the only one that produces reported earnings, we consider identification of the first three to be the key to building value for Berkshire shareholders. In selecting common stocks, we devote our attention to attractive purchases, not to the possibility of attractive sales.
So value was enhanced over many years but the gains had to be recognized all at once as accounting earnings in that one year.
Adam
* Earnings do not include the amortization of Goodwill. From the letter: ...amortization of Goodwill is not charged against the specific businesses but, for reasons outlined in the Appendix to my letter in the 1983 annual report, is aggregated as a separate item. The reason comes down to the difference between economic and accounting Goodwill. The Appendix in the 1983 letter does a nice job of explaining this.
Monday, January 30, 2012
Buffett: High Current Yield, Long-term Capital Growth, and Stock Market Pyrotechnics
From the 1979 Berkshire Hathaway (BRKa) Shareholder Letter:
Phil Fisher, a respected investor and author, once likened the policies of the corporation in attracting shareholders to those of a restaurant attracting potential customers. A restaurant could seek a given clientele - patrons of fast foods, elegant dining, Oriental food, etc. - and eventually obtain an appropriate group of devotees. If the job were expertly done, that clientele, pleased with the service, menu, and price level offered, would return consistently. But the restaurant could not change its character constantly and end up with a happy and stable clientele. If the business vacillated between French cuisine and take-out chicken, the result would be a revolving door of confused and dissatisfied customers.
So it is with corporations and the shareholder constituency they seek. You can't be all things to all men, simultaneously seeking different owners whose primary interests run from high current yield to long-term capital growth to stock market pyrotechnics, etc.
The reasoning of managements that seek large trading activity in their shares puzzles us. In effect, such managements are saying that they want a good many of the existing clientele continually to desert them in favor of new ones - because you can't add lots of new owners (with new expectations) without losing lots of former owners.
We much prefer owners who like our service and menu and who return year after year. It would be hard to find a better group to sit in the Berkshire Hathaway shareholder "seats" than those already occupying them. So we hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policies, and shares our expectations.
What Buffett describes above would seem nearly impossible to find in today's short-term oriented capital markets culture (with many participants now buying/selling via ETFs & employing other short-term trading strategies).
Yet, wherever possible, I'll take investing alongside an investor constituency of informed long-term owners that don't head for the exits at the first sign of trouble in a business (or the macro environment).
These days, quite a few market participants seem to have no shortage of an attention deficit, employing strategies that often make business fundamentals an afterthought (if at all).
Among those that do actually happen to look at fundamental business values from time to time, more than a few seem to embrace the if you don't like near term prospects just sell the stock school of investing. This includes small investor and large institutions alike.* At some level, there's nothing wrong with that, I suppose. Investors and other market participants are free to invest any way they want, of course.
Yet, I'd prefer investing next to a high percentage of co-owners and executives that can be trusted to stick around during the inevitable rough patches (macro or otherwise). Even the best businesses will, at times, experience real but fixable difficulties (I'm not talking about truly broken businesses here). When change intended to improve long-term returns are needed, long-term committed owners, especially those that control a large % of stock, are more apt to use their influence to work with and put pressure on the board and management to fix real problems.**
In the real world, things rarely work anywhere near this ideal but investing with other long-term oriented owners and managers when possible at least improves the odds of shareholder-friendly actions. It also has the advantage of allowing an investor to gain in-depth knowledge and insight into the unique risks/potential of a specific business. It's not possible to know a lot about every business so it helps to concentrate on what one truly can understand. In this approach, returns are generated by the compounded wealth creation of a good business over time, bought at reasonable or better prices, not well-timed trades (something that has been emphasized more than a few times on this blog).
A good business, even one with occasional short-term problems, is a franchise capable of high and sustainable return on capital (superior economics). Long-term portfolio returns can only be above average if the businesses in the portfolio generally produce above average return on capital. A business with below average economics will produce subpar long-term returns even if it is bought at what seems like a substantial discount (though it is possible to make money over a shorter horizon this way).
Now, clearly sometimes having a few co-owners that lack long-term conviction is a benefit. It allows the long-term owners to accumulate more shares from the weak holders. It also may allow the company to buyback shares on the cheap. That's fine up to a point. Yet, there's another less optimal (if more subtle) side to this. Let's say a large block of shareholders (lacking in long-term conviction) are susceptible to selling temporarily depressed shares during times of market stress. This sets up a situation where a smart outside buyer could come along and pay a nice premium to the market price but still well below what remaining committed long-term owners consider anywhere near fair intrinsic value. If enough low-in-conviction co-owners are willing to sell the temporarily depressed shares to this buyer, then the judgment of the business intrinsically being worth more, even if correct, won't matter.
(Of course, it's possible to be a long-term committed owner that is overly optimistic about value and better off with that buyout.)
This may seem improbable but it certainly can happen. So that's just another reason why the more informed and long-term oriented the other owners are the better.
None of this, of course, is particularly easy to judge for a smaller investor, but I still think it's still worth putting any long-term investment through this kind of mostly subjective filter. At some level, the way the market is structured today (speculative activity of various kinds in favor of investing) makes this way of thinking difficult to put into practice.
Difficult yet not irrelevant.
It may be at odds with much of today's investing culture but, at least at the margin, finding businesses where an informed shareholder constituency is generally on board for the long haul is worth it.
Capital put at risk by informed, patient long-term shareholders increases the probability of (though hardly guarantees) improved results. Owners and agents concerned with price action measured in months (or even just a few years) will likely make different decisions than those concerned with the creation of enduring value over, say, 20 years. Most good businesses have the chance to compound at a rate closer to full potential with shareholders, the board, and management all focused upon long-term effects.
Investors as a whole should, on average, end up better off. More importantly, if the main participants were focused upon long-term effects, capital markets would likely function more effectively when it comes to the crucial role of facilitating capital allocation.
Wise capital and other resource allocation is more likely to happen when more owners are in it for the long run (informed about/engaged in what the board and key executives are doing with the resources of the business they own).
Instead, it seems an increasingly extreme amount of mental energy is expended by market participants speculating on near-term stock price action. I think it is safe to say that there are real costs (some hidden, some explicit and obvious) when the proportion of speculative versus investing activities goes to an extreme.***
Well, in a typical recent year, ...our financial system has directed around $200 billion a year into initial public offerings and additional new public offerings and then additional offerings of company stock--$200 billion. We trade $40 trillion worth of stocks a year. So, that's 200 times as much speculation as there is investment. - John Bogle on Speculation Dwarfing Investment
There's nothing wrong with speculation.
It will always have a place in the markets but the proportion matters.
Adam
* That small investors behave this way is somewhat understandable, since they cannot usually influence the board and management. In many cases it's necessary to move on due to that lack of influence. For agents and/or investors capable of owning enough shares to influence corporate governance practices and other strategic decisions it seems much less understandable.
** Knowing that there are a few smart larger co-owners is always nice when management/board governance/other strategic changes end up being needed in a business. Otherwise, I think about shares of a business the same way I think about owning a good smaller business 100%. A small or medium size private business owner doesn't generally bail if some near-term serious but manageable problem emerges. Why not then, at least most of the time, treat share ownership of public businesses with that mindset? For me, reasons to sell include when the economic moat of a business becomes materially damaged and is likely to become even more so over time. In other words, the core long-term economics fundamentally change. Also, sometimes valuation will go to an extreme high. For me, short-term difficulties associated with the macro environment or a specific but fixable problem in the business aren't generally good reasons to sell a sound business that I like. There are, of course, times that funds are needed for a clearly superior alternative long-term investment. So outside of the business economics fundamentally breaking down, an extreme valuation, or high opportunity costs, my bias is to own the shares of a good business (bought well) for a very long time.
*** By just about any measure speculation is at unprecedented levels. The average holding period of stocks is now around 3 months while the average holding period during most of the past century was measured in multiple years.
Phil Fisher, a respected investor and author, once likened the policies of the corporation in attracting shareholders to those of a restaurant attracting potential customers. A restaurant could seek a given clientele - patrons of fast foods, elegant dining, Oriental food, etc. - and eventually obtain an appropriate group of devotees. If the job were expertly done, that clientele, pleased with the service, menu, and price level offered, would return consistently. But the restaurant could not change its character constantly and end up with a happy and stable clientele. If the business vacillated between French cuisine and take-out chicken, the result would be a revolving door of confused and dissatisfied customers.
So it is with corporations and the shareholder constituency they seek. You can't be all things to all men, simultaneously seeking different owners whose primary interests run from high current yield to long-term capital growth to stock market pyrotechnics, etc.
The reasoning of managements that seek large trading activity in their shares puzzles us. In effect, such managements are saying that they want a good many of the existing clientele continually to desert them in favor of new ones - because you can't add lots of new owners (with new expectations) without losing lots of former owners.
We much prefer owners who like our service and menu and who return year after year. It would be hard to find a better group to sit in the Berkshire Hathaway shareholder "seats" than those already occupying them. So we hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policies, and shares our expectations.
What Buffett describes above would seem nearly impossible to find in today's short-term oriented capital markets culture (with many participants now buying/selling via ETFs & employing other short-term trading strategies).
Yet, wherever possible, I'll take investing alongside an investor constituency of informed long-term owners that don't head for the exits at the first sign of trouble in a business (or the macro environment).
These days, quite a few market participants seem to have no shortage of an attention deficit, employing strategies that often make business fundamentals an afterthought (if at all).
Among those that do actually happen to look at fundamental business values from time to time, more than a few seem to embrace the if you don't like near term prospects just sell the stock school of investing. This includes small investor and large institutions alike.* At some level, there's nothing wrong with that, I suppose. Investors and other market participants are free to invest any way they want, of course.
Yet, I'd prefer investing next to a high percentage of co-owners and executives that can be trusted to stick around during the inevitable rough patches (macro or otherwise). Even the best businesses will, at times, experience real but fixable difficulties (I'm not talking about truly broken businesses here). When change intended to improve long-term returns are needed, long-term committed owners, especially those that control a large % of stock, are more apt to use their influence to work with and put pressure on the board and management to fix real problems.**
In the real world, things rarely work anywhere near this ideal but investing with other long-term oriented owners and managers when possible at least improves the odds of shareholder-friendly actions. It also has the advantage of allowing an investor to gain in-depth knowledge and insight into the unique risks/potential of a specific business. It's not possible to know a lot about every business so it helps to concentrate on what one truly can understand. In this approach, returns are generated by the compounded wealth creation of a good business over time, bought at reasonable or better prices, not well-timed trades (something that has been emphasized more than a few times on this blog).
A good business, even one with occasional short-term problems, is a franchise capable of high and sustainable return on capital (superior economics). Long-term portfolio returns can only be above average if the businesses in the portfolio generally produce above average return on capital. A business with below average economics will produce subpar long-term returns even if it is bought at what seems like a substantial discount (though it is possible to make money over a shorter horizon this way).
Now, clearly sometimes having a few co-owners that lack long-term conviction is a benefit. It allows the long-term owners to accumulate more shares from the weak holders. It also may allow the company to buyback shares on the cheap. That's fine up to a point. Yet, there's another less optimal (if more subtle) side to this. Let's say a large block of shareholders (lacking in long-term conviction) are susceptible to selling temporarily depressed shares during times of market stress. This sets up a situation where a smart outside buyer could come along and pay a nice premium to the market price but still well below what remaining committed long-term owners consider anywhere near fair intrinsic value. If enough low-in-conviction co-owners are willing to sell the temporarily depressed shares to this buyer, then the judgment of the business intrinsically being worth more, even if correct, won't matter.
(Of course, it's possible to be a long-term committed owner that is overly optimistic about value and better off with that buyout.)
This may seem improbable but it certainly can happen. So that's just another reason why the more informed and long-term oriented the other owners are the better.
None of this, of course, is particularly easy to judge for a smaller investor, but I still think it's still worth putting any long-term investment through this kind of mostly subjective filter. At some level, the way the market is structured today (speculative activity of various kinds in favor of investing) makes this way of thinking difficult to put into practice.
Difficult yet not irrelevant.
It may be at odds with much of today's investing culture but, at least at the margin, finding businesses where an informed shareholder constituency is generally on board for the long haul is worth it.
Capital put at risk by informed, patient long-term shareholders increases the probability of (though hardly guarantees) improved results. Owners and agents concerned with price action measured in months (or even just a few years) will likely make different decisions than those concerned with the creation of enduring value over, say, 20 years. Most good businesses have the chance to compound at a rate closer to full potential with shareholders, the board, and management all focused upon long-term effects.
Investors as a whole should, on average, end up better off. More importantly, if the main participants were focused upon long-term effects, capital markets would likely function more effectively when it comes to the crucial role of facilitating capital allocation.
Wise capital and other resource allocation is more likely to happen when more owners are in it for the long run (informed about/engaged in what the board and key executives are doing with the resources of the business they own).
Instead, it seems an increasingly extreme amount of mental energy is expended by market participants speculating on near-term stock price action. I think it is safe to say that there are real costs (some hidden, some explicit and obvious) when the proportion of speculative versus investing activities goes to an extreme.***
Well, in a typical recent year, ...our financial system has directed around $200 billion a year into initial public offerings and additional new public offerings and then additional offerings of company stock--$200 billion. We trade $40 trillion worth of stocks a year. So, that's 200 times as much speculation as there is investment. - John Bogle on Speculation Dwarfing Investment
There's nothing wrong with speculation.
It will always have a place in the markets but the proportion matters.
Adam
* That small investors behave this way is somewhat understandable, since they cannot usually influence the board and management. In many cases it's necessary to move on due to that lack of influence. For agents and/or investors capable of owning enough shares to influence corporate governance practices and other strategic decisions it seems much less understandable.
** Knowing that there are a few smart larger co-owners is always nice when management/board governance/other strategic changes end up being needed in a business. Otherwise, I think about shares of a business the same way I think about owning a good smaller business 100%. A small or medium size private business owner doesn't generally bail if some near-term serious but manageable problem emerges. Why not then, at least most of the time, treat share ownership of public businesses with that mindset? For me, reasons to sell include when the economic moat of a business becomes materially damaged and is likely to become even more so over time. In other words, the core long-term economics fundamentally change. Also, sometimes valuation will go to an extreme high. For me, short-term difficulties associated with the macro environment or a specific but fixable problem in the business aren't generally good reasons to sell a sound business that I like. There are, of course, times that funds are needed for a clearly superior alternative long-term investment. So outside of the business economics fundamentally breaking down, an extreme valuation, or high opportunity costs, my bias is to own the shares of a good business (bought well) for a very long time.
*** By just about any measure speculation is at unprecedented levels. The average holding period of stocks is now around 3 months while the average holding period during most of the past century was measured in multiple years.
Wednesday, January 4, 2012
Buffett: "Hyperkinetic" Investment Managers
From the 1986 Berkshire Hathaway (BRKa) Shareholder Letter:
We should note that we expect to keep permanently our three primary holdings, Capital Cities/ABC, Inc., GEICO Corporation, and The Washington Post. Even if these securities were to appear significantly overpriced, we would not anticipate selling them, just as we would not sell See's or Buffalo Evening News if someone were to offer us a price far above what we believe those businesses are worth.
This attitude may seem old-fashioned in a corporate world in which activity has become the order of the day. The modern manager refers to his "portfolio" of businesses - meaning that all of them are candidates for "restructuring" whenever such a move is dictated by Wall Street preferences, operating conditions or a new corporate "concept." (Restructuring is defined narrowly, however: it extends only to dumping offending businesses, not to dumping the officers and directors who bought the businesses in the first place. "Hate the sin but love the sinner" is a theology as popular with the Fortune 500 as it is with the Salvation Army.)
Investment managers are even more hyperkinetic: their behavior during trading hours makes whirling dervishes appear sedated by comparison. Indeed, the term "institutional investor" is becoming one of those self-contradictions called an oxymoron...
Despite the enthusiasm for activity that has swept business and financial America, we will stick with our 'til-death-do-us-part policy. It's the only one with which Charlie and I are comfortable, it produces decent results, and it lets our managers and those of our investees run their businesses free of distractions.
Buffett wrote that in an era when the average holding period for stocks was in the 2 to 3 year range. These days, the average holding period is more like a few months. So if Buffett saw market participants as hyperkinetic, whirling dervishes back then what does he think now?
Roughly 25 years ago, Buffett said he expected to keep the three primary holdings permanently. Here's what happened to those three stocks:
-In 1995, Walt Disney Co. (DIS) offered to buy Capital Cities/ABC, Inc. and closed on the deal in early 1996. Berkshire received cash and Disney stock in exchange for the 20 million Capital Cities/ABC shares owned by Berkshire (cost basis $ 345 million but worth around $ 2.5 billion at the end of 1995). The Disney shares were only held for a few more years. The Walt Disney Co. shares haven't done much in the decade plus since they were sold, but the business has done just fine. Another case where business value had to "catch up" to a bloated price to earnings ratio.
-Also in 1996, Berkshire purchased the remainder of GEICO's stock they did not already own causing the company to be converted into a wholly-owned subsidiary.
-Washington Post (WPO), of course, remains in the Berkshire equity portfolio.
So Buffett and Munger may often go in with the intention to own something "forever". At least so far, for two out of the three that's what has happened. In fact, by buying the remaining shares of GEICO the commitment to GEICO as a long-term investment has been only increased.
Naturally, over a longer time frame, something unforeseeable comes along like the Disney-Cap Cities/ABC deal where the buyer wants the business and is willing to pay a price for the shares that is attractive enough to the seller.
It's not that selling never makes sense. If the moat deteriorates to where the economics become very unattractive (especially if a large percent of net worth), or cash is needed to fund the purchase of an unusually attractive investment, sometimes a sale makes good sense. Yet, a bias toward not selling once you own shares of a good business (or an entire business, of course) minimizes frictional costs, and potential mistakes, while allowing the long-term effects of compounding to benefit long-term owners.
Adam
We should note that we expect to keep permanently our three primary holdings, Capital Cities/ABC, Inc., GEICO Corporation, and The Washington Post. Even if these securities were to appear significantly overpriced, we would not anticipate selling them, just as we would not sell See's or Buffalo Evening News if someone were to offer us a price far above what we believe those businesses are worth.
This attitude may seem old-fashioned in a corporate world in which activity has become the order of the day. The modern manager refers to his "portfolio" of businesses - meaning that all of them are candidates for "restructuring" whenever such a move is dictated by Wall Street preferences, operating conditions or a new corporate "concept." (Restructuring is defined narrowly, however: it extends only to dumping offending businesses, not to dumping the officers and directors who bought the businesses in the first place. "Hate the sin but love the sinner" is a theology as popular with the Fortune 500 as it is with the Salvation Army.)
Investment managers are even more hyperkinetic: their behavior during trading hours makes whirling dervishes appear sedated by comparison. Indeed, the term "institutional investor" is becoming one of those self-contradictions called an oxymoron...
Despite the enthusiasm for activity that has swept business and financial America, we will stick with our 'til-death-do-us-part policy. It's the only one with which Charlie and I are comfortable, it produces decent results, and it lets our managers and those of our investees run their businesses free of distractions.
Buffett wrote that in an era when the average holding period for stocks was in the 2 to 3 year range. These days, the average holding period is more like a few months. So if Buffett saw market participants as hyperkinetic, whirling dervishes back then what does he think now?
Roughly 25 years ago, Buffett said he expected to keep the three primary holdings permanently. Here's what happened to those three stocks:
-In 1995, Walt Disney Co. (DIS) offered to buy Capital Cities/ABC, Inc. and closed on the deal in early 1996. Berkshire received cash and Disney stock in exchange for the 20 million Capital Cities/ABC shares owned by Berkshire (cost basis $ 345 million but worth around $ 2.5 billion at the end of 1995). The Disney shares were only held for a few more years. The Walt Disney Co. shares haven't done much in the decade plus since they were sold, but the business has done just fine. Another case where business value had to "catch up" to a bloated price to earnings ratio.
-Also in 1996, Berkshire purchased the remainder of GEICO's stock they did not already own causing the company to be converted into a wholly-owned subsidiary.
-Washington Post (WPO), of course, remains in the Berkshire equity portfolio.
So Buffett and Munger may often go in with the intention to own something "forever". At least so far, for two out of the three that's what has happened. In fact, by buying the remaining shares of GEICO the commitment to GEICO as a long-term investment has been only increased.
Naturally, over a longer time frame, something unforeseeable comes along like the Disney-Cap Cities/ABC deal where the buyer wants the business and is willing to pay a price for the shares that is attractive enough to the seller.
It's not that selling never makes sense. If the moat deteriorates to where the economics become very unattractive (especially if a large percent of net worth), or cash is needed to fund the purchase of an unusually attractive investment, sometimes a sale makes good sense. Yet, a bias toward not selling once you own shares of a good business (or an entire business, of course) minimizes frictional costs, and potential mistakes, while allowing the long-term effects of compounding to benefit long-term owners.
Adam
Tuesday, December 20, 2011
Buffett on Profitability: For Commodity Businesses, "Nothing Fails Like Success"
From the 1982 Berkshire Hathaway (BRKa) Shareholder Letter:
Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner and thereby insulated at least partially from normal market forces. This administration can be carried out (a) legally through government intervention (until recently, this category included pricing for truckers and deposit costs for financial institutions), (b) illegally through collusion, or (c) "extra- legally" through OPEC-style foreign cartelization (with tag-along benefits for domestic non-cartel operators).
If, however, costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.
Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking for a "two-ounce candy bar") but doesn't work with sugar (how often do you hear, "I'll have a cup of coffee with cream and C & H sugar, please").
In many industries, differentiation simply can't be made meaningful. A few producers in such industries may consistently do well if they have a cost advantage that is both wide and sustainable. By definition such exceptions are few, and, in many industries, are non-existent. For the great majority of companies selling "commodity" products, a depressing equation of business economics prevails: persistent over-capacity without administered prices (or costs) equals poor profitability.
Of course, over-capacity may eventually self-correct, either as capacity shrinks or demand expands. Unfortunately for the participants, such corrections often are long delayed. When they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates over-capacity and a new profitless environment. In other words, nothing fails like success.
What finally determines levels of long-term profitability in such industries is the ratio of supply-tight to supply-ample years. Frequently that ratio is dismal. (It seems as if the most recent supply-tight period in our textile business - it occurred some years back - lasted the better part of a morning.)
In some industries, however, capacity-tight conditions can last a long time. Sometimes actual growth in demand will outrun forecasted growth for an extended period. In other cases, adding capacity requires very long lead times because complicated manufacturing facilities must be planned and built.
Capacity-tight conditions can persist for a very long time.
After several years of experiencing what seems like a favorable profitability environment, an investor can be lulled into thinking the recent experience represents what is normal.
(I mean, when something goes on for many years, it's not hard to make the mistake of projecting things indefinitely forward.)
So watch a commodity business put up five or seven years (maybe more) of outsized profitability and it's easy to incorrectly interpret the performance as ongoing. Yet, in all likelihood, over a long enough cycle, that profitability will eventually shrink or even become persistent losses (possibly for a very long time) as the capacity/demand imbalances are corrected.
When an executive at a commodity business decides to invest in new capacity, assumptions need to be made in order to judge the likely pricing environment many years down the road. Get it wrong (either due to weaker demand than expected or too much unexpected new capacity) and the returns end up sub-par or much worse.
No business is easy but getting that judgment consistently right seems difficult at best.
When the added capacity (often with a substantial time lag...enough for the macro world to have changed a whole lot) does come on line, what seemed like persistent profitability can shift and dramatically so.
The problem is that for most commodity businesses the fixed investments are enormous. Also, commodity prices fluctuate in ways that a differentiated product or service generally does not.
(compare Coca-Cola's beverage or Pepsi's snack prices over a few business cycles to suppliers of copper, oil, sugar etc.)
All commodity business equity investments need to be looked at carefully in this light.
Is the recent period (even if a very long cycle) of profitability a precursor to something much different once new capacity comes online or demand takes a hit?
Does the business have a sustainable cost advantage and a conservative balance sheet that lets it outlast competitors during the supply-ample years?
None of this is really an issue for businesses that can differentiate product and service and wrap a trusted brand around it.
In contrast to commodity-like businesses, even during times of economic stress, you'll rarely see more than a small hit to profitability* to products and services that can be differentiated.
Adam
* The commodity price spikes that occurred in recent years were certainly a headache for consumer goods businesses but the hit to profitability for most was actually rather modest.
Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner and thereby insulated at least partially from normal market forces. This administration can be carried out (a) legally through government intervention (until recently, this category included pricing for truckers and deposit costs for financial institutions), (b) illegally through collusion, or (c) "extra- legally" through OPEC-style foreign cartelization (with tag-along benefits for domestic non-cartel operators).
If, however, costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.
Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking for a "two-ounce candy bar") but doesn't work with sugar (how often do you hear, "I'll have a cup of coffee with cream and C & H sugar, please").
In many industries, differentiation simply can't be made meaningful. A few producers in such industries may consistently do well if they have a cost advantage that is both wide and sustainable. By definition such exceptions are few, and, in many industries, are non-existent. For the great majority of companies selling "commodity" products, a depressing equation of business economics prevails: persistent over-capacity without administered prices (or costs) equals poor profitability.
Of course, over-capacity may eventually self-correct, either as capacity shrinks or demand expands. Unfortunately for the participants, such corrections often are long delayed. When they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates over-capacity and a new profitless environment. In other words, nothing fails like success.
What finally determines levels of long-term profitability in such industries is the ratio of supply-tight to supply-ample years. Frequently that ratio is dismal. (It seems as if the most recent supply-tight period in our textile business - it occurred some years back - lasted the better part of a morning.)
In some industries, however, capacity-tight conditions can last a long time. Sometimes actual growth in demand will outrun forecasted growth for an extended period. In other cases, adding capacity requires very long lead times because complicated manufacturing facilities must be planned and built.
Capacity-tight conditions can persist for a very long time.
After several years of experiencing what seems like a favorable profitability environment, an investor can be lulled into thinking the recent experience represents what is normal.
(I mean, when something goes on for many years, it's not hard to make the mistake of projecting things indefinitely forward.)
So watch a commodity business put up five or seven years (maybe more) of outsized profitability and it's easy to incorrectly interpret the performance as ongoing. Yet, in all likelihood, over a long enough cycle, that profitability will eventually shrink or even become persistent losses (possibly for a very long time) as the capacity/demand imbalances are corrected.
When an executive at a commodity business decides to invest in new capacity, assumptions need to be made in order to judge the likely pricing environment many years down the road. Get it wrong (either due to weaker demand than expected or too much unexpected new capacity) and the returns end up sub-par or much worse.
No business is easy but getting that judgment consistently right seems difficult at best.
When the added capacity (often with a substantial time lag...enough for the macro world to have changed a whole lot) does come on line, what seemed like persistent profitability can shift and dramatically so.
The problem is that for most commodity businesses the fixed investments are enormous. Also, commodity prices fluctuate in ways that a differentiated product or service generally does not.
(compare Coca-Cola's beverage or Pepsi's snack prices over a few business cycles to suppliers of copper, oil, sugar etc.)
All commodity business equity investments need to be looked at carefully in this light.
Is the recent period (even if a very long cycle) of profitability a precursor to something much different once new capacity comes online or demand takes a hit?
Does the business have a sustainable cost advantage and a conservative balance sheet that lets it outlast competitors during the supply-ample years?
None of this is really an issue for businesses that can differentiate product and service and wrap a trusted brand around it.
In contrast to commodity-like businesses, even during times of economic stress, you'll rarely see more than a small hit to profitability* to products and services that can be differentiated.
Adam
* The commodity price spikes that occurred in recent years were certainly a headache for consumer goods businesses but the hit to profitability for most was actually rather modest.
Tuesday, July 19, 2011
Buffett on Enduring Competitive Advantage: Berkshire Shareholder Letter Highlights
From the 2000 Berkshire Hathaway (BRKa) Shareholder Letter:
Despite State Farm's strengths, however, GEICO has much the better business model, one that embodies significantly lower operating costs. And, when a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. This enduring competitive advantage of GEICO - one it possessed in 1951 when, as a 20-year-old student, I first became enamored with its stock - is the reason that over time it will inevitably increase its market share significantly while simultaneously achieving excellent profits.
You see this fits a pattern when you consider what Buffett said a couple years ago about two very different types of businesses. He spoke of Wells Fargo (WFC) and more generally about copper producers in this CNBC interview to highlight the importance of a sustainable low-cost position. The "raw material" for a bank, of course, is money and the cost of it relative to competitors is all-important. The same is true for a copper producer:
If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot. - Warren Buffett talking to CNBC on May 2, 2009
An enduring low cost position is one source of competitive advantage that you'll see at the core of Berkshire Hathaway's portfolio of businesses (whether partially owned via shares in common stocks or owned outright).
Another common stock held within the Berkshire portfolio that has a low cost position is Wal-Mart (WMT).
...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill. - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Having an enduring low cost advantage is one important source of economic Goodwill. In the 1983 letter, Buffett goes on to explain what he thinks the major sources of economic Goodwill happen to be:
...a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry. - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Coca-Cola (KO), Kraft (KFT), Johnson & Johnson (JNJ), and See's Candy are all good examples of enduring consumer franchises.
An idea related to all of this is the economic moat of a business. It's a term referring to the characteristics that determine the longevity of competitive advantage for a single business within an industry. The economic moat protects a firms excess return potential.
Some moats are sustainable for decades while others are not.
Whether a business can sustain or enhance its moat to protect those excess returns is the key question.
You'll find many other examples of consumer franchises and low cost producers in the Berkshire Hathaway portfolio.
The businesses Berkshire owns partially (in the case of common stocks) or entirely tend to derive their competitive advantages from one of these two sources.
Check out the portfolio and it becomes pretty clear most of the businesses have at least one of these two forms of competitive advantage.
Adam
* Accounting Goodwill is very different from economic Goodwill. The appendix in the 1983 Berkshire Hathaway Shareholder Letter provides a complete explanation of the difference between economic Goodwill and accounting Goodwill. From the letter: This appendix deals only with economic and accounting Goodwill – not the goodwill of everyday usage. For example, a business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, before the breakup, was generally well thought of, but possessed not a dime of economic Goodwill.) And, regrettably, a business may be disliked by its customers but possess substantial, and growing, economic Goodwill. So, just for the moment, forget emotions and focus only on economics and accounting.
Despite State Farm's strengths, however, GEICO has much the better business model, one that embodies significantly lower operating costs. And, when a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important. This enduring competitive advantage of GEICO - one it possessed in 1951 when, as a 20-year-old student, I first became enamored with its stock - is the reason that over time it will inevitably increase its market share significantly while simultaneously achieving excellent profits.
You see this fits a pattern when you consider what Buffett said a couple years ago about two very different types of businesses. He spoke of Wells Fargo (WFC) and more generally about copper producers in this CNBC interview to highlight the importance of a sustainable low-cost position. The "raw material" for a bank, of course, is money and the cost of it relative to competitors is all-important. The same is true for a copper producer:
If you're a copper producer, and copper is selling for two dollars a pound, and you want to measure the stress of copper going to $1.30, for a guy whose production cost is $1.50, you know, he's got problems. If his cost is a dollar, he doesn't have problems. And Wells, in terms of its raw material costs, is better situated than any large bank, by some margin. So, it's built to sustain a lot. - Warren Buffett talking to CNBC on May 2, 2009
An enduring low cost position is one source of competitive advantage that you'll see at the core of Berkshire Hathaway's portfolio of businesses (whether partially owned via shares in common stocks or owned outright).
Another common stock held within the Berkshire portfolio that has a low cost position is Wal-Mart (WMT).
...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill. - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Having an enduring low cost advantage is one important source of economic Goodwill. In the 1983 letter, Buffett goes on to explain what he thinks the major sources of economic Goodwill happen to be:
...a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill.
Other sources include governmental franchises not subject to profit regulation, such as television stations, and an enduring position as the low cost producer in an industry. - Warren Buffett in 1983 Berkshire Hathaway Shareholder Letter
Coca-Cola (KO), Kraft (KFT), Johnson & Johnson (JNJ), and See's Candy are all good examples of enduring consumer franchises.
An idea related to all of this is the economic moat of a business. It's a term referring to the characteristics that determine the longevity of competitive advantage for a single business within an industry. The economic moat protects a firms excess return potential.
Some moats are sustainable for decades while others are not.
Whether a business can sustain or enhance its moat to protect those excess returns is the key question.
You'll find many other examples of consumer franchises and low cost producers in the Berkshire Hathaway portfolio.
The businesses Berkshire owns partially (in the case of common stocks) or entirely tend to derive their competitive advantages from one of these two sources.
Check out the portfolio and it becomes pretty clear most of the businesses have at least one of these two forms of competitive advantage.
Adam
* Accounting Goodwill is very different from economic Goodwill. The appendix in the 1983 Berkshire Hathaway Shareholder Letter provides a complete explanation of the difference between economic Goodwill and accounting Goodwill. From the letter: This appendix deals only with economic and accounting Goodwill – not the goodwill of everyday usage. For example, a business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, before the breakup, was generally well thought of, but possessed not a dime of economic Goodwill.) And, regrettably, a business may be disliked by its customers but possess substantial, and growing, economic Goodwill. So, just for the moment, forget emotions and focus only on economics and accounting.
Monday, May 9, 2011
Buffett on Coca-Cola, See's & Railroads: Berkshire Shareholder Letter Highlights
"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us." - Warren Buffett in the 2007 Berkshire Hathaway Shareholder Letter
From these excellent 2011 Berkshire Hathaway (BRKa) meeting notes taken by Ben Claremon:
Question 8: Crowd - Aside from not needing to put huge amounts of capital to work, are Coke and See's still great business to own in an inflationary situation? Are they better than companies with irreplaceable hard assets and pricing power (like the railroad) in protecting against inflation?
Buffett: The first businesses are superior. If you have a great consumer product that requires very little capital to grow and support that growth--and you do more volume as inflation grows — that is a wonderful asset to protect against inflation. The ultimate example of that is your own earning ability. People who have made investments in themselves — outstanding teachers and doctors — see their wages increase with inflation. They also don't have to make an additional investment in themselves. People should think about a long term real estate asset like a farm where additional capital is not required to finance inflationary growth.
The worst businesses are the ones with huge receivables and inventories. Their volume stays flat and they have to come up with more money to finance that volume. Normally BRK does not like businesses that require a lot of capital — railroads and utilities. But, he and Charlie believe that they should be able to generate a good return in the railroad because of the value it provides to the economy. The ideal business is one like See's. See's Candy was doing $25M-$30M in revenue when they bought it and they were selling 16M* pounds of candy. Now they are doing over $300M in revenue. It took $9M of capital then and the business only needs $40M in tangible capital now. If the price of candy doubles they don't have any receivables or inventory. Fixed assets don't have to increase either.
It may not be obvious why a slow growth business like See's produces terrific returns. Just about everyday on business news and analyst reports you'll see, more often than not, the focus on future growth prospects.
Makes sense intuitively, right?
Not necessarily. That focus on growth is often misplaced.
The growth focus would make sense in a world where durable competitive advantage, pricing power, and the minimal need for incremental capital could be taken for granted in a business. For most businesses, that world doesn't exist.
Many businesses have grown much faster than See's for decades but end up lacking in some of the above qualities (or all the above qualities in the case of airlines) so investor returns ended up sub-par.
See's volumes have grown barely 2% per year since Berkshire bought it back in 1972 yet returns have been fantastic.
So if See's can achieve great returns with modest growth then the business with even higher growth and See's great characteristics must be even better, right?
In theory, if you can find a business like that...yes. In theory.
While there may be rare exceptions, in the real world, a business with See's-like economics that happens to also be growing very fast will eventually attract more competition. Having a well-executed first mover advantage matters but it's intense competition (there are some very good businesses that provoke little competition, in part, because of unexciting or modest growth characteristics) that might make what look like great economics today into not so great economics down the road.
So yes there are exceptions but they reside within the more unpredictable competitive environments (a place where more mistakes are likely to be made).
In both the 2007 Berkshire Hathaway Shareholder Letter and 1983 Berkshire Hathaway Shareholder Letter, Buffett provides an explanation of the characteristics that make See's a superior business.
For convenience, here are some previous posts (and excerpts) on See's that cover this ground.
From the 2007 Berkshire Hathaway Shareholder Letter:
Buffett on See's Candy
"Let's look at the prototype of a dream business, our own See's Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn't grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See's, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.
At See's, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See's sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire."
Later Buffett continues....
"Last year See's sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us. (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.)"
From the 1983 Berkshire Hathaway Shareholder Letter:
Buffett on Economic Goodwill
"...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.
In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See's – doing it, furthermore, with conservative accounting and no financial leverage. It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill."
I think See's is one of the more useful business case studies because it reveals that a business with: 1) durable competitive advantage, pricing power, and the minimal need for capital trumps growth, and 2) while the value of economic goodwill will not be found on a balance sheet it is extremely important and very real.
See's is a superior business because it is durable and, despite little in the way of growth prospects, it produces a high return on capital for the investor. The source of that high return on capital is its unique combination of qualities (durable competitive advantages, pricing power, modest needs incremental capital etc.).
Other businesses may not necessarily be the equal of See's but possess many of these same qualities (A hint: look in the cupboard).
See's as a case study seems simple and in many ways it is. I'm guessing the deceptive simplicity may make some say to themselves:
"There's got to be more to it than this."
Well, there really isn't.
The ideas just need to be internalized and applied with discipline. The bottom line: understanding See's more fully makes sense because the lessons from it are potentially lucrative for long-term investors.
Adam
* The notes had 60M pounds as the number but the actual is 16M. More than understandable when typing that fast with no recording device. All in all, these are the best Berkshire notes I've seen.
From these excellent 2011 Berkshire Hathaway (BRKa) meeting notes taken by Ben Claremon:
Question 8: Crowd - Aside from not needing to put huge amounts of capital to work, are Coke and See's still great business to own in an inflationary situation? Are they better than companies with irreplaceable hard assets and pricing power (like the railroad) in protecting against inflation?
Buffett: The first businesses are superior. If you have a great consumer product that requires very little capital to grow and support that growth--and you do more volume as inflation grows — that is a wonderful asset to protect against inflation. The ultimate example of that is your own earning ability. People who have made investments in themselves — outstanding teachers and doctors — see their wages increase with inflation. They also don't have to make an additional investment in themselves. People should think about a long term real estate asset like a farm where additional capital is not required to finance inflationary growth.
The worst businesses are the ones with huge receivables and inventories. Their volume stays flat and they have to come up with more money to finance that volume. Normally BRK does not like businesses that require a lot of capital — railroads and utilities. But, he and Charlie believe that they should be able to generate a good return in the railroad because of the value it provides to the economy. The ideal business is one like See's. See's Candy was doing $25M-$30M in revenue when they bought it and they were selling 16M* pounds of candy. Now they are doing over $300M in revenue. It took $9M of capital then and the business only needs $40M in tangible capital now. If the price of candy doubles they don't have any receivables or inventory. Fixed assets don't have to increase either.
It may not be obvious why a slow growth business like See's produces terrific returns. Just about everyday on business news and analyst reports you'll see, more often than not, the focus on future growth prospects.
Makes sense intuitively, right?
Not necessarily. That focus on growth is often misplaced.
The growth focus would make sense in a world where durable competitive advantage, pricing power, and the minimal need for incremental capital could be taken for granted in a business. For most businesses, that world doesn't exist.
Many businesses have grown much faster than See's for decades but end up lacking in some of the above qualities (or all the above qualities in the case of airlines) so investor returns ended up sub-par.
See's volumes have grown barely 2% per year since Berkshire bought it back in 1972 yet returns have been fantastic.
So if See's can achieve great returns with modest growth then the business with even higher growth and See's great characteristics must be even better, right?
In theory, if you can find a business like that...yes. In theory.
While there may be rare exceptions, in the real world, a business with See's-like economics that happens to also be growing very fast will eventually attract more competition. Having a well-executed first mover advantage matters but it's intense competition (there are some very good businesses that provoke little competition, in part, because of unexciting or modest growth characteristics) that might make what look like great economics today into not so great economics down the road.
So yes there are exceptions but they reside within the more unpredictable competitive environments (a place where more mistakes are likely to be made).
In both the 2007 Berkshire Hathaway Shareholder Letter and 1983 Berkshire Hathaway Shareholder Letter, Buffett provides an explanation of the characteristics that make See's a superior business.
For convenience, here are some previous posts (and excerpts) on See's that cover this ground.
From the 2007 Berkshire Hathaway Shareholder Letter:
Buffett on See's Candy
"Let's look at the prototype of a dream business, our own See's Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn't grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See's, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.
At See's, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See's sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire."
Later Buffett continues....
"Last year See's sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us. (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.)"
From the 1983 Berkshire Hathaway Shareholder Letter:
Buffett on Economic Goodwill
"...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.
In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See's – doing it, furthermore, with conservative accounting and no financial leverage. It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill."
I think See's is one of the more useful business case studies because it reveals that a business with: 1) durable competitive advantage, pricing power, and the minimal need for capital trumps growth, and 2) while the value of economic goodwill will not be found on a balance sheet it is extremely important and very real.
See's is a superior business because it is durable and, despite little in the way of growth prospects, it produces a high return on capital for the investor. The source of that high return on capital is its unique combination of qualities (durable competitive advantages, pricing power, modest needs incremental capital etc.).
Other businesses may not necessarily be the equal of See's but possess many of these same qualities (A hint: look in the cupboard).
See's as a case study seems simple and in many ways it is. I'm guessing the deceptive simplicity may make some say to themselves:
"There's got to be more to it than this."
Well, there really isn't.
The ideas just need to be internalized and applied with discipline. The bottom line: understanding See's more fully makes sense because the lessons from it are potentially lucrative for long-term investors.
Adam
* The notes had 60M pounds as the number but the actual is 16M. More than understandable when typing that fast with no recording device. All in all, these are the best Berkshire notes I've seen.
Thursday, March 17, 2011
Buffett, Bogle, and the Invisible Foot
"...consider a typical company earning, say, 12% on equity. Assume a very high turnover rate in its shares of 100% per year. If a purchase and sale of the stock each extract commissions of 1% (the rate may be much higher on low-priced stocks) and if the stock trades at book value, the owners of our hypothetical company will pay, in aggregate, 2% of the company's net worth annually for the privilege of transferring ownership. This activity does nothing for the earnings of the business, and means that 1/6 of them are lost to the owners through the "frictional" cost of transfer. (And this calculation does not count option trading, which would increase frictional costs still further.)
All that makes for a rather expensive game of musical chairs. Can you imagine the agonized cry that would arise if a governmental unit were to impose a new 16 2/3% tax on earnings of corporations or investors? By market activity, investors can impose upon themselves the equivalent of such a tax."
Later Buffett goes on to say...
"These expensive activities may decide who eats the pie, but they don't enlarge it.
(We are aware of the pie-expanding argument that says that such activities improve the rationality of the capital allocation process. We think that this argument is specious and that, on balance, hyperactive equity markets subvert rational capital allocation and act as pie shrinkers. Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy.)"
Consider that this was written during a time when trading volumes were quaint by comparison to today (although partially offset by today's lower commission costs).
Partially.
Let's look at the trading volumes and resulting frictional costs of S&P 500 Index ETF (SPY) in our modern context. John Bogle recently pointed out the SPY turns over 10,000%/year.
"Well, the ETF has got to be one of the great marketing ideas of the recent era. I think it remains to be seen whether it’s one of the great investment ideas of the recent era. The trading volumes are astonishing. Standard & Poor’s 500 SPDR (SPY), the biggest one, turns over 10,000% a year, and I think 30% turnover is too high. What does one say about 10,000%?" - John Bogle
So take that turnover rate and assume a .05% average commission cost (for example: $ 10 of commissions...$ 5 for the buyer and $ 5 for the seller on a $ 20,000 average purchase amount of SPY). Using these simplistic but I think meaningful assumptions, what's the rough annualized frictional costs for the average participant in the SPY during a calender year based upon current behavior?
It comes out to a little over 5% per year plus the modest .09% fund expenses:
$ 10/trade x 10,000% percent annual turnover + $ 20,000 x .09% = $ 1,018
That's $ 1,018 of expenses per year on the $ 20,000 purchase amount or just over 5%.
In other words, if these assumptions are even close to correct, the average participant in SPY would make only 4% if the S&P 500 went up 9% per year going forward. This, of course, does not apply to participants wise enough to just buy and hold the SPY. Yet, for the average participant, 4% would in fact be the approximate per annum return (again, based upon current typical market participant behavior).
Only those involved in the hyperactive trading of SPY bear the costs. Those that buy and hold do not (they pay a mere $ 18/year on $ 20,000 invested plus a modest commission expense).
Under the above scenario, buy and hold behavior would seem to provide a 5%/year advantage over the average participant in that fund (those driving that 10,000% turnover volume).
If correct, more than half the returns of that ETF is being drained off in the form of commissions. What Jeremy Grantham calls a "raid" of the balance sheet.
Taking money that would be capital and converting it to income (in the form of salary, commissions, bonuses etc to your favorite broker).
Now, in this case the frictional costs are not being caused by raising fees but the effect is the same. Instead, the frictional cost is caused by investor behavior itself (well, actually trader behavior or whoever plays the "rather expensive game of musical chairs").
The fact is a quality ETF like the SPY (if traded minimally) can be an incredibly convenient low frictional cost way to invest.
So much like my Fermi guesstimate above, it's likely that a good portion of that performance gap comes from all the frictional costs associated with trading ETFs so frequently.
All that makes for a rather expensive game of musical chairs. Can you imagine the agonized cry that would arise if a governmental unit were to impose a new 16 2/3% tax on earnings of corporations or investors? By market activity, investors can impose upon themselves the equivalent of such a tax."
Later Buffett goes on to say...
"These expensive activities may decide who eats the pie, but they don't enlarge it.
(We are aware of the pie-expanding argument that says that such activities improve the rationality of the capital allocation process. We think that this argument is specious and that, on balance, hyperactive equity markets subvert rational capital allocation and act as pie shrinkers. Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy.)"
Consider that this was written during a time when trading volumes were quaint by comparison to today (although partially offset by today's lower commission costs).
Partially.
Let's look at the trading volumes and resulting frictional costs of S&P 500 Index ETF (SPY) in our modern context. John Bogle recently pointed out the SPY turns over 10,000%/year.
"Well, the ETF has got to be one of the great marketing ideas of the recent era. I think it remains to be seen whether it’s one of the great investment ideas of the recent era. The trading volumes are astonishing. Standard & Poor’s 500 SPDR (SPY), the biggest one, turns over 10,000% a year, and I think 30% turnover is too high. What does one say about 10,000%?" - John Bogle
So take that turnover rate and assume a .05% average commission cost (for example: $ 10 of commissions...$ 5 for the buyer and $ 5 for the seller on a $ 20,000 average purchase amount of SPY). Using these simplistic but I think meaningful assumptions, what's the rough annualized frictional costs for the average participant in the SPY during a calender year based upon current behavior?
It comes out to a little over 5% per year plus the modest .09% fund expenses:
$ 10/trade x 10,000% percent annual turnover + $ 20,000 x .09% = $ 1,018
That's $ 1,018 of expenses per year on the $ 20,000 purchase amount or just over 5%.
In other words, if these assumptions are even close to correct, the average participant in SPY would make only 4% if the S&P 500 went up 9% per year going forward. This, of course, does not apply to participants wise enough to just buy and hold the SPY. Yet, for the average participant, 4% would in fact be the approximate per annum return (again, based upon current typical market participant behavior).
Only those involved in the hyperactive trading of SPY bear the costs. Those that buy and hold do not (they pay a mere $ 18/year on $ 20,000 invested plus a modest commission expense).
Under the above scenario, buy and hold behavior would seem to provide a 5%/year advantage over the average participant in that fund (those driving that 10,000% turnover volume).
If correct, more than half the returns of that ETF is being drained off in the form of commissions. What Jeremy Grantham calls a "raid" of the balance sheet.
Taking money that would be capital and converting it to income (in the form of salary, commissions, bonuses etc to your favorite broker).
Now, in this case the frictional costs are not being caused by raising fees but the effect is the same. Instead, the frictional cost is caused by investor behavior itself (well, actually trader behavior or whoever plays the "rather expensive game of musical chairs").
The fact is a quality ETF like the SPY (if traded minimally) can be an incredibly convenient low frictional cost way to invest.
Now, the above admittedly is a bit of a Fermi Estimate. The question: Is that estimate, at least, in the ball park of being correct? Let's look at a broader set of ETFs that were tracked by Vanguard and referenced by John Bogle in this interview:
Bogle said among the pitfalls are that ETFs "turn over at a fantastic rate and they reflect the public appetite for performance chasing."
When Vanguard tracked the returns on 175 ETFs recently, said Bogle, it found investors fell about six percent short per year of the actual index the ETFs were designed to track—adding up to a 30 percent gap over five years.
So much like my Fermi guesstimate above, it's likely that a good portion of that performance gap comes from all the frictional costs associated with trading ETFs so frequently.
"Human nature being what it is, most people assume away worries like those I raise. After all, five centuries before Christ Demosthenes noted that: 'What a man wishes, he will believe.' And in self-appraisals of prospects and talents it is the norm, as Demosthenes predicted, for people to be ridiculously over-optimistic. For instance, a careful survey in Sweden showed that 90% of automobile drivers considered themselves above average. And people who are successfully selling something, as investment counselors do, make Swedish drivers sound like depressives. Virtually every investment expert's public assessment is that he is above average, no matter what is the evidence to the contrary." - Charlie Munger
The above is from a speech in 1998 to the Foundation Financial Officers Group sponsored by The Conrad Hilton Foundation.
The above is from a speech in 1998 to the Foundation Financial Officers Group sponsored by The Conrad Hilton Foundation.
Just like the study of Swedish drivers, many probably think they will chase the performance of the SPY at just the right time and end up above average. The evidence suggests otherwise and by definition the total return of investors as a whole can be no larger than the total return of the fund minus frictional costs.
Newton's 4th Law.
Adam
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