Berkshire Hathaway 1st Quarter 2013 13F-HR

The Berkshire Hathaway (BRKa) 1st Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 4th Quarter 13F-HR.)

There was plenty of buying and selling during the quarter. Here's a quick summary of the changes:*

New Positions
Chicago Bridge & Iron (CBI): Bought 6.51 million shares worth $ 376 million
Liberty Media (LMCA): 5.62 million shares worth $ 714 million**

Added to Existing Positions
Wells Fargo (WFC): Bought 18.3 million shares worth $ 720 million, total stake now $ 18.0 billion
IBM (IBM): 6.50 thousand shares worth $ 1.3 million, total stake $ 13.9 billion
Wal-Mart (WMT): 1.75 million shares worth $ 139 million, total stake $ 3.93 billion

DirecTV (DTV): 3.24 million shares worth $ 211 million, total stake $ 2.43 billion
U.S. Bancorp (USB): 193.5 thousand shares worth $ 6.64 million, total stake $ 2.1 billion

DaVita (DVA): 1.37 million shares worth $ 178 million, total stake $ 1.95 billion (Previously disclosed in SEC filings. Also, a "Standstill Agreement" between Berkshire-DaVita is now in place.)
National Oilwell Varco (NOV): 2.19 million shares worth $ 149 million, total stake $ 510 million
Verisign (VRSN): 4.49 million shares worth $ 403 million
Wabco Holdings (WBC): 4.40 thousand shares worth $ 341 thousand, total stake $ 316 million

In the 1st quarter of 2013, there apparently was nothing purchased that was kept confidential. Berkshire's 13F-HR filings will sometimes say: "Confidential information has been omitted from the Form 13F and filed separately with the Commission."

Not this time.

Occasionally, the SEC allows Berkshire Hathaway to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Reduced Positions
BNY Mellon (BK): Sold 695 thousand shares worth $ 21 million, total stake $ 572 million
Mondelez International (MDLZ): 5.79 million shares worth $ 182 million, total stake $ 222 million
Kraft Foods Group (KRFT): 66.7 thousand shares worth $ 3.7 million, total stake $ 88.4 million

Sold Positions
Archer Daniels Midland (ADM)
General Dynamics (GD)

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio, even if they still manage only a small percentage of the overall portfolio.

These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial (approaching ~ 40%) and consumer stocks (~ 30%).

The remainder is spread across technology (primarily IBM), energy, communication services, healthcare, and industrials.

1. Wells Fargo (WFC) = $ 18.0 billion
2. Coca-Cola (KO) = $ 17.2 billion
3. IBM (IBM) = $ 13.9 billion
4. American Express (AXP) = $ 11.0 billion
5. Procter and Gamble (PG) = $ 4.26 billion

As is almost always the case, it's a very concentrated portfolio.

The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus cash and cash equivalents, fixed income, and other investments.***

The combined portfolio value (equities, bonds, cash, and other investments) was just under $ 200 billion at the end of the most recent quarter.

The above portfolio, of course, excludes all the operating businesses that Berkshire owns outright with ~ 288,000 employees.

Here are some examples of the non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candy, Dairy Queen, The Pampered Chef, Business Wire, Iscar Metalworking, Lubrizol, and the Oriental Trading Company.
(Among others.)

In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.

See page 106 of the annual report for a full list of the operating businesses.

Adam

* All values based upon yesterday's closing price.
** The Starz/Liberty Media spin-off was completed earlier this year (spin-off of Liberty from Starz). Liberty Media changed its name to Starz and trades as STRZA. The spin-off is called Liberty Media Corporation and trades as LMCA. These new shares are a reflection of the spin-off. So Berkshire now owns shares of both STRZA and LMCA.
*** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares (POSCO, Sanofi, Tesco PLC, etc.) is updated in the annual letter. So the only way any of these stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Things like the preferred shares in Bank of America are also not included in the 13F-HR. 
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Charlie Munger: What Buying a Housing and Rabbit Hunting Have in Common

Charlie Munger recently weighed in on this past decade's boom and bust in the housing market during an interview with CNBC's Becky Quick.

In the interview, Charlie Munger took some time to use rabbit hunting as a way to help explain what happened during the housing crisis:

"Partly there was a time you felt foolish you didn't buy a house because you weren't making all the money everybody else was making, so it was a typical crazy boom. Now people have learned house prices can go down as well as up."

Munger then added this:

"It's like a fella who goes rabbit hunting and thoroughly enjoys himself. And then the rabbits haul out guns and start firing back. It would dim your enthusiasm for rabbit hunting, and that's what happened in the housing market."

For another good example of a "typical crazy boom",and the "rabbits" eventually "firing back", consider long ago what happened to Sir Isaac Newton during the South Sea Bubble.

Chart: Isaac Newton's Nightmare

Anyone who thinks that a high IQ is protection against foolish investing behavior should consider what happened to the otherwise often brilliant Sir Isaac.

The exchange about housing and rabbits starts at around the 24:12 point in the video. Check it out. Munger's delivery often adds a bit of an edge to the words.

Here's my summary of some of the other points that Charlie Munger made about what contributed to the real estate boom and subsequent crisis:

- We were building more houses than we needed leading inevitably to a glut driven by unwise home lending and bond financing. It was a combination of extreme stupidity and extreme immorality. This all led to what should not be considered an unexpected result (Munger also described it as "craziness and crookedness").

- Both the government and private sector had a role in it. Stupidity, incompetence, and venality behind it.

"We were exceptional in stupidity and immorality and we paid the price."

- We've learned our lesson either not at all or only somewhat. The new rules meant to reign in the worst behavior aren't strong enough. Take the easy money out of the system.

"The people who used to make the money they can hardly wait to start doing it again. The rest of us are going to have to curtail them."

- There's nothing wrong with pro-housing policies. We just don't need housing loans that aren't sound. We don't need a policy that leads to building lots of unneeded houses. We don't need the "fraud and folly" in the business of issuing securities who'll unload them on whoever will buy them.

These sorts of things combined with excess leverage (much of it via cheap and what probably seemed at the time like reliably available short-term funding) and insufficient liquidity among other things was just asking for trouble.

There needs to be stronger limits in place to prevent the same set of behaviors that got us into trouble from re-emerging. Maybe this has been accomplished to some degree, but Charlie Munger seems far from convinced of this. Some of the excesses -- probably in some creative new form -- seem certain to come back if we aren't careful to prevent it.

The interview is well worth listening to in its entirety. As is often the case, Charlie Munger had many other useful and insightful things to say.

Adam

Buffett on Bonds and Productive Assets

From this past Monday's interview of Warren Buffett by CNBC's Becky Quick:

"I bought a piece of real estate in New York in 1992, I have not had a quote on it since. I look to the performance of the assets. Maybe...my piece of real estate have had pull backs, but I don't even know about 'em. People pay way too— way too much attention to the short term. If you're getting your money's worth in a stock, buy it and forget it."

He then added this on interest rates and how they affect all other assets:

"...interest rates act like gravity to other asset prices. Everything is based off them."

Buffett then also said:

"...interest rates have a powerful effect on...all assets. Real estate, farms, oil, everything else...they're the cost of carrying other assets. They're the alternative. They're the yardstick."

Interest rates may be the yardstick, but the time to buy certainly isn't when the world is free of trouble.

"...the fact that there are troubles in Europe, and there are plenty of troubles, and they're not going go away fast, does not mean you don't buy stocks. We bought stocks when the United States was in trouble, in 2008 and— and it was in huge trouble and we spent 15 1/2 billion in three weeks in— between September 15th and October 10th. It wasn't because the news was good, it was because the prices were good."

He also said that, while he doesn't have any idea when, some day bond yields will be a lot higher.

"Oh...it's going to happen. And question is...the question is always when. I'm no good on that. The question is to what degree it happens. But you could have interest rates very significantly different than what they are now— in some reasonable period in the future. It's not a game that I can play. I mean, I— I don't have any special insight into that sort of thing..."

As far as Buffett's concerned stocks might have been cheap not long ago, but they're now merely decent values.

"In terms of stocks, you know, stocks are reasonably priced. They were very cheap a few years ago. They're reasonably priced now. But stocks grow in value over time because they retain earnings..."

Bonds, on the other hand...

"There could be conditions under which we...would own bonds. But— they're conditions far different than what exist now."

Becky Quick then pointed out that her co-host on CNBC's Squawk Box, Joe Kernen, went into a retirement specialist recently. The specialist said he should be 40% in bonds. Buffett's response was "you shouldn't be 40% in bonds." He said investors with the "proper attitude" should have "enough cash on hand so they feel comfortable, and then the rest in equities..."

He then added:

"I would have productive assets. I would favor those enormously over fixed dollars investments now, and I think it's silly — to have some ratio like 30 or 40 or 50% in bonds. They're terrible investments now."

Of course, productive assets include not just equities (pieces of businesses) but naturally also entire businesses, as well as things like farms and real estate. As always, they must be attractive assets bought at attractive valuations. Even the best asset can be a dumb and risky investment at the wrong price.

Buffett did explain what he meant specifically by "proper attitude".

He said it's those investors who won't be bothered whether stocks were to drop, for example, 20% in the next month.

Now, 20% over the next month was used to help make his point, but it's not really about a specific percentage.*

It's just that those who tend to react the wrong way to negative price action aren't likely to do very well in equities. In fact, those who react emotionally to price action in either direction will likely end up with poor results in the long run. That more than a few investors tend to buy and sell at the wrong times is, unfortunately, an all too reliable pattern. Buying when the news appears good and selling when the outlook appears less rosy or seems more uncertain isn't a brilliant way to invest. The fact that a favorable outlook makes it feel safer doesn't mean that it is. All else equal, the higher prices that will generally prevail during the good times increases the risk of permanent capital loss (and, of course, the lower prices often available during the not so good times reduce that risk.) Investors often try to time their moves but the evidence is that this is mostly a good idea in theory only. It is likely to increase mistakes and just generally reduce returns.
(Though I'm sure there's some who are able to do this sort of thing...it's just that far more seem to think they can do this effectively than the available evidence suggests.)

The intrinsic value of most quality productive assets simply doesn't move around nearly as much as stock market prices. With so much inherent price movement, eventually sound long-term investments should become available at a discount.

Investment is attempting to capture the long-term compounding of real value, instead of the near-term price movements. That the macro environment will go sour from time to time over a true investment horizon is inevitable. Expect it while realizing that attempts at correctly timing it is folly. The evidence that attempts at properly timing moves consistently well is not smart thing to do isn't insignificant yet, no doubt, many will still ignore this reality.

The good news is that timing things well isn't important over the long haul, paying the right price is.

In any case, buying when the skies are clear then selling during the storm is a great way to pay more than necessary for assets and, ultimately, sell them for too little.

More risk, less reward.

It's clearly not impossible to counteract this adverse tendency, but that starts with being aware of it.

Buffett's not always against the ownership of bonds by the way. In the interview, he points out that he made a lot of money in zero coupon bonds in the early 1980s and added that "...the price of everything determines its attractiveness."

Buffett said that a few years ago "The news was terrible, but the stocks were cheap, you know. News is better now. Stocks are higher. They're still not— they're not ridiculously high at all, and bonds are priced artificially. You've got some guy buying $85 billion a month. (LAUGH) And— that will change at some point. And when it changes, people could lose a lot of money if they're in long-term bonds."

Much later in the interview, Buffett once again talked about the folly of trying to buy and sell stocks based on current news. He said those that do this are "giving away an enormous advantage" then added:

"...I bought a farm in 1985, I haven't had— had a quote on it since. But I know what it's produced every year. And I know it's worth more money now. You know, it— if I'd gotten a quote on it every day and somebody's said, "You know, maybe you oughta sell because there's, you know, there's clouds in the West," or something. (LAUGH) It's — it's crazy."

Investment, in contrast to speculation, has as its focus what a productive asset can produce over a long time frame. Of course, what you pay for that asset -- whether it be an entire business, part of a business, or a farm. or other real estate -- matters. Many think of the stock market primarily in terms of where prices will be over the near or even intermediate term. Learning to think primarily about what something will produce over time instead of price action can make all the difference.

In this recent post, I mentioned that Buffett last year said "bonds should come with a warning label." Then, as now, he wasn't saying when yields would rise. Getting the timing right is always difficult at best. In fact, it is mostly a waste of energy or worse. The good news is that timing things consistently well is not a requirement when it comes to getting attractive investment results. Look no further than Warren Buffett himself for evidence of this.

As Donald Yacktman and his team like to say" "It's almost all about the price."

That just about sums it up. It's buying productive assets, particularly those that the individual investor understands well, at a price that represents a nice discount to per share intrinsic value.

Adam

* To make his point about the "proper attitude", Buffett used stocks going down 20% in the next month as an example. In this interview back in 2009, Charlie Munger talked about stocks dropping more like 50%:

"I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by say 50%."

The point isn't really the percentage. It's to focus on what an asset is intrinsically worth and buy it cheap enough instead of focusing on what the quoted price happens to be on any given day. If cheap, and you want more of a particular asset, buy more. If expensive, and you want less of the asset, then maybe sell. Otherwise, ignore the quoted prices and use that energy making sure value has been judged well. Better yet, if justifiably confident about an assets prospects, expend that energy elsewhere once enough shares are owned at an attractive valuation. The bottom line is to keep fear and greed in check and just mostly ignore the quoted prices. Emotional reactions cloud investment judgments and destroy returns.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

2013 Berkshire Shareholder Meeting - Part II: Buffett on Timing Purchases

***Update: Separated today's earlier post into Part I & Part II. A shorter version of the following was initially in Part I.***

According to The Motley Fool, here's what Warren Buffett said at the 2013 Berkshire Hathaway (BRKa) shareholder meeting about attempting to time the purchase of marketable securities:

"If they try to time their purchases they will do very well for their broker and not very well for themselves."

I realize some will continue to try and time their purchases (and maybe some are even good at it), but the right time to buy or sell any asset is rarely if ever obvious. The good news is it's not all that important to get the timing right if you can judge value well, and always buy that value at a discount (i.e. dollar bills for fifty cents, especially if those "dollar bills" increase intrinsically in value over time as most good businesses do).

The right price to pay for an asset may not be an easy thing to figure out but is, by comparison, at least doable with some work (and a good understanding of business economics, of course).

Those that try to get the timing and price right are making the job more difficult than it needs to be. When something becomes plainly expensive, avoid it. When something becomes plainly cheap, buy it. Always buy with a nice margin of safety. Do these things consistently well and timing things right becomes far less relevant in the long run.

It is as Seth Klarman said in his 2010 annual letter:

"Risk is not inherent in an investment; it is always relative to the price paid."

What's sensible and low risk at one price is risky at some higher price. Getting that right consistently is difficult enough.

Add timing to the equation and errors of omission along with other misjudgments are almost certain to increase.

In the short run (and even longer), poorly timed investments can certainly lead to temporary paper losses -- sometimes rather substantial. Market prices in the short run can do just about anything.* That's a problem for those who speculate on price action. Yet, for those that take more of a long-term investment approach, a declining price shouldn't matter as long as the price paid represents a discount to per share intrinsic value and the business has attractive and durable core economics. If anything, it is a net benefit when prices go lower over the near-term or even intermediate term since more shares can be bought below value (both by the company via buybacks and by the investor over time). It is only when it comes time to sell that an investor should hope that price fully reflects the -- if a good business -- increased per share intrinsic value many years down the road.

So getting the timing wrong matters little in the long run if an investor generally judges value of a good business correctly in the first place and buys at a price that represents a discount. In the short run, the "voting machine" can create nonsensical prices but, in the long run, the "weighing machine" will adjust to something that more closely reflects per share intrinsic business value.

It's only when price versus value is judged poorly that the long-term investor becomes exposed to the risk of permanent capital loss.

It's getting the valuation roughly right, within a range, then make purchases with an appropriate margin of safety to account for most of the worst outcomes.

The appropriate margin of safety is necessarily different for each investment.

For the long-term investor, getting price versus value right is all-important. Attempts to also get the timing right is often just a foolish distraction and, worst case, very costly.

Tempting, yes, but generally unwise.

Adam

Long position in BRKb established at much lower than recent prices

* Paper losses may not be pleasant but consider this: When a business that isn't public is bought (with the intent to own it longer term), the new owner(s) generally will not focus on what someone else tells them it is worth day after day (or, in the case of the stock market, every second). They focus on the income stream the business produces. They focus on whether that stream of income relative to the price they paid remains attractive. They don't sit their considering what other "voters" are saying the business is worth in the short-term or even longer. To a business owner, the price of only matters when buying or selling. It's the same for a partial owner of a business but unfortunately the minute-by-minute quoted value becomes a distraction for many market participants. It is only those speculating on market price action who should expend their energy thinking about near-term quoted prices.
** Missing the chance to build a meaningful position in (or missing entirely) a well understood business you like that was at one point was sensibly priced.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

2013 Berkshire Shareholder Meeting - Part I: Not Picking Stocks By The Numbers

***Update: Separated this post into Part I & Part II. The bottom half of the original version of this post is now in Part II.***

In an interesting exchange at the 2013 Berkshire Hathaway (BRKa) shareholder meeting, Warren Buffett and Charlie Munger made it clear that, for them, the numbers play a lesser role than some might otherwise think when it comes to picking stocks.

Their focus is on how a business (whether buying an entire business or shares of the business) will be doing in ten years or so. For Buffett and Munger, it's about what the competitive advantages will look like many years from now.

Here's part of the exchange as summarized by the Wall Street Journal's live blog of this year's meeting:

"We are looking at businesses exactly like we are looking at them if somebody came in and asked us to buy the whole business," Buffett said. He said they then want to know how it will do in ten years. 

Munger was even more forceful: "We don't know how to buy stocks by metrics ... We know that Burlington Northern will have a competitive advantage in years ... we don't know what the heck Apple will have. ... You really have to understand the company and its competitive positions. ... That's not disclosed by the math.

Buffett: "I don't know how I would manage money if I had to do it just on the numbers."

Munger, interupting, "You'd do it badly."

It's mostly not about the numbers but I'm guessing at least some who hear or read this don't completely believe it. There's got to be more of a heavy numerical emphasis in their analysis, right?

Nope.

Maybe those who don't quite buy this are picturing instead something like these huge proprietary Berkshire spreadsheets, other complex analytical tools and methods, that they just aren't willing to reveal. That's simply not the case. Most of what matters whether buying pieces of businesses (in the case of marketable stocks) or buying entire businesses can't be seen in the numbers. Consider this Wall Street Journal article from a while back on how Buffett likes to operate:

He keeps no calculator on his desk, preferring to do most calculations in his head. "I deplore false precision in math," he says, explaining that he does not need exact numbers for most investment decisions.

There's also the following comment from Charlie Munger during his 2003 UC Santa Barbara speech that I've referenced before:

"You've got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, [yet] there's no precise numbering you can put to these factors. You know they're important, but you don't have the numbers. Well practically (1) everybody overweighs the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and (2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that."

Understanding competitive advantages and whether they will remain in place for a very long time matters a whole lot. Yet much of what's important in this regard just isn't quantifiable or, at least, can't be measured very well.

Naturally the numbers matter to an extent. It's just that some assume that valuations need to be estimated via complex methods. They don't. In fact, with investing it is the simple methods that are often more useful. Approximate value does have to be estimated in a meaningful way but doesn't require a bunch of complex calculations and higher forms of math. Additional unneeded complexity often just leads to precisely the wrong answers.

A good understanding of accounting is important, of course. Unfortunately, the accounting numbers are only a starting point and have to be translated into something economically meaningful. That's not necessarily an easy thing to do consistently well.

There are many ways to misjudge a business if an investor doesn't know how to read and interpret what's in a 10-K, 10-Q, and other SEC filings. Again, interpreting the financial statements is important, but much of what matters in investment analysis is not going to be found in the numbers.

I'll get to more from the meeting in a follow up.

Adam

2013 Berkshire Shareholder Meeting - Part II: Buffett on Timing Purchases

Long positions in BRKb and AAPL established at much lower than recent prices

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Apple's Debt Offering: Investor Enthusiasm for Bonds Continues

Earlier this week, Apple (AAPL) sold the largest corporate non-financial bond deal in history.

Apple sold, in total, $ 17 billion in new corporate debt.

It wasn't just historically large, the cost of the funds themselves were historically low.

The huge decline in Treasury interest rates -- a key driver of corporate debt -- has led to some incredibly cheap funding for companies. Some that don't, in many ways, even seem to really need it in an operational sense but, if your stock happens to be cheap (or you'd like to refinance some expensive debt), quite an opportunity.*

The 10-year Treasury currently has a yield of ~1.75%. This compares to a little over 15x earnings for stocks in the S&P 500 according to these estimates. Of course, expressed as an earnings yield (inverse price  to earnings) that would be ~ 6.6%.

A quick summary of Apple's debt deal:

3-year variable: $ 1 billion at .33%
5 year variable: $ 2 billion at .53%
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3 year fixed: $ 1.5 billion at .511%
5 year fixed: $ 5.0 billion at 1.076%
10 year fixed: $ 5.5 billion at 2.415%
30-year fixed: $ 3.0 billion at 3.883%
Total: $ 17.0 billion at a 1.85% blended rate**

Forbes: Apple Bond Summary

Let's step back a bit. This Wall Street Journal article points out that, according to Lipper (a unit of Thomson Reuters), a record $55 billion flowed into bond mutual funds and investment-grade bond ETFs over the first 17 weeks of 2013.

So there's plenty of demand these days with investors buying especially the higher quality corporate bonds undeterred by the rather low yields.

Well, as a comparison, consider this article written back in February of 2000. It points out how willing investors were to invest in aggressive, high-risk equity funds at a time when stock were quite expensive and, as it turned out, near their peak.

"...investors are gravitating toward--not running away from--high-growth, high-risk sectors thus far in 2000."

So there was plenty of demand for stock funds especially the riskiest variety:

"...Janus, Fidelity, Vanguard and Invesco, reported extremely strong flows in January, a month that saw much market volatility. Much of the money is going into technology, telecom, biotechnology and/or growth funds, company officials say.

In December, 'aggressive-growth' funds attracted $11.5 billion in net new money, whereas more conservative "growth-and-income" funds saw net redemptions of nearly $6 billion.

'That's just unheard of,' said Carl Wittnebert, director of research for the Santa Rosa, Calif.-based research firm Trimtabs.com. 'The public has developed this wild appetite for risk.'

Meanwhile, investors have all but lost their appetite for bond funds, coming off a year in which rising interest rates hurt the principal value of many bond portfolios. Taxable bond funds saw outflows of $6.2 billion in December."

At that time, stocks were already expensive by any measure -- a number were selling at 30x, 40x, 50x earnings and much more -- and the 10-year Treasury was 6.6% (coincidentally, same as the S&P 500's earnings yield right now). So back then, it was pretty close (though not exactly) to the opposite of where we are today as far as valuations go. In the year 2000, investor enthusiasm for stocks was rather high and money was flowing into stock funds -- especially the riskiest variety -- when they were quite expensive.***
(Keep in mind that the riskier funds would likely have owned stocks selling for higher than average multiples of earnings -- if there was any earnings at all -- at that time.)

Now, the enthusiasm is for bonds and record levels of money is flowing into bond funds -- especially the seemingly safest variety. Instead of the "wild appetite for risk" that existed in 2000, many investors seem to have a "wild appetite for safety".

Or, at least, perceived safety. The problem is that safety might be mostly illusion.

I'm not suggesting stocks, in general, are cheap these days. To me, they are not generally cheap though there certainly are some not particularly expensive individual securities.

It's just that investors who are now pouring their money into bonds these days should be considering carefully whether today's yield really provides sufficient compensation considering the risks. Bonds may be perceived as generally safer than productive assets (i.e. businesses, partial ownership of businesses via marketable stocks, farms, real estate etc.) but the risk an investor is taking always comes down to the price one has to pay. I'm guessing how bonds have performed over the past several decades has only reinforced the perception of relative safety. I mean, yields going from where they were three or so decades ago to where they are now has been a tailwind to say the least. Who knows when that tailwind reverses in a meaningful way, but when it does it will not be pleasant. For bonds or currency-based investments more generally, I think Warren Buffett said it best in last year's letter:

"Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as "safe." In truth they are among the most dangerous of assets."

Buffett later added this:

"Right now bonds should come with a warning label."

What's sensible and low risk at one price is risky at another price. It is as Seth Klarman said in his 2010 annual letter:

"Risk is not inherent in an investment; it is always relative to the price paid."

The right time to buy or sell any asset is likely to rarely if ever obvious ahead of time.

The right price to pay for an asset may not be an easy thing to figure out but is, by comparison, at least doable with some work.

Those that try to get the timing and price right are making the job more difficult than it needs to be. When something becomes plainly expensive, avoid it. When something becomes plainly cheap, buy it. Do that consistently well and timing things right becomes far less relevant in the long run.

I'm not suggesting that the enthusiasm for bonds is the equivalent to the extreme enthusiasm for stocks in the late 1990s up until they peaked in 2000. Whether that's the case will likely only become broadly obvious at some point down the road.

Still, what does seem clear is that bonds provide little in the way of margin of safety these days and have lots of downside long-term bought near prevailing prices.

Some other items of note on the Apple bond offering:

- The bond offering was Apple's first in almost 20 years.

- According to Reuters, the offering brought in than $50 billion in orders. So lots of demand to say the least.

- The company was able to borrow at nearly triple-A rates but not quite. Apple's debt is rated AA-plus by Standard & Poor's.

- Microsoft (MSFT), with its AAA debt rating, sold 10-year bonds at a yield of 2.413% last week; almost the exact same rate as Apple with its slightly lower debt rating.

- Apple sold the three year floating-rate bonds at 0.05 percentage points over the 3-month London interbank offered rate (LIBOR).

- Apple sold the five year floating-rate bonds at 0.25 percentage points over the 3-month LIBOR.

This borrowing will help, in part, fund a plan to return $100 billion to shareholders (dividends plus $ 60 billion in buybacks) by the end of 2015.

Apple has tons of cash, of course. More than enough to fund a buyback and pay the dividends they have in mind. The problem has been that much of it is overseas and not accessible without incurring taxes (if the funds were brought back to the United States). Raising cash in the bond market helps the company avoid that tax bill.

The 1.85% blended rate is less than Apple's ~ 2.7% current dividend yield (and much less than the company's earnings yield, of course), so each share repurchased will eliminate more in dividend payments than the borrowing cost of the funds themselves.

Keep in mind that interest is tax deductible, while dividends are not. So, with interest being tax deductible, the 1.85% blended after-tax cost to Apple will naturally be even less.

In any case, at least near current prices, the company comes out explicitly ahead when a share is repurchased (and will continue to as long as after-tax interest expense < dividend yield).

In the long run, as always, what matters to continuing long-term shareholders is whether shares can be repurchased comfortably below Apple's per share intrinsic value. Well, at least for me, Apple's per share intrinsic value isn't that easy judge even though its economic performance has been quite impressive to say the least in recent years.
(It would be more easy to judge value if recent performance could be considered reliably indicative of Apple's future economic prospects. When financial results improve as rapidly as they have for Apple in recent years, it's not a bad idea to at least have some healthy skepticism about it being sustainable. Ben Graham makes this point in Chapter 12 of The Intelligent Investor. It's often better to use a multiple year average especially when there's been a recent earnings spike. That doesn't mean Apple won't still do just fine, but their recent exceptional margins on substantial revenue increases may have to continue normalizing -- as they already have been to an extent. Someone else might be more convinced that the recent performance should be considered more indicative of future prospects, of course, and, who knows, they may just be right.)

Apple clearly has many fine, difficult to replicate, business attributes (and what they have accomplished in a short time is rather astonishing) but that doesn't change the fact that it competes in fast changing markets against well-financed, capable competitors (not unlike, if not quite equal to, Apple itself) and sometimes against fresh competitors (who occasionally seem to come out of nowhere); it doesn't change the fact that it depends heavily on rapid innovation; it doesn't change the reality that not always easy to predict technology shifts do occur. Businesses with durable competitive advantages often have characteristics, and are dealing with industry dynamics, that are mostly just the opposite of this.

This poses real challenges for someone trying to narrow down intrinsic value -- or really what has to necessarily be a range of values. That doesn't mean Apple isn't a great company but the focus here is on investment outcomes. It just means, for the investor, that the estimated range of values seems almost certainly rather wide for a company like Apple.

So, the tough part -- at least compared to some alternatives -- is figuring out how Apple's competitive advantages might change over time and, as a result, what its core economics will look like many years down the road.

Judging what Apple is likely worth isn't impossible but there is definitely a wider range of outcomes. To me, that means an obvious and more substantial than average margin of safety must exist if it is to be bought at all. Some have the legitimate concern margins will inevitably decline meaningfully; that even the somewhat reduced margins compared to the recent peak are unsustainable. If they turn out to be correct -- and they just may be at least in part -- what now seems cheap may turn out to be quite a bit less so or worse.

Apple has no doubt created a great brand around products and services that have earned the trust and loyalty of its many customers. For that reason, it seems impossible to not admire Apple as a company. Yet, the reality is that Apple is a highly dependent on innovation business (their own innovation and that of others) even if the company has many rather impressive qualities. So, as far as the investment process goes, that makes long run economic prospects harder to gauge.

It will never be a favorite investment of mine but the brand strength combined with the earned trust and loyalty of it's customers -- if not violated -- is, undeniably, real and valuable.

Having said that, it won't surprise me at all if Apple's business does very well. It's just that, as a long-term investment (not a speculative trade), the company can't be put in the same category as those with more plain to see long-term durable advantages.

Businesses that possess competitive advantages that are likely to persist for many years (if not decades) generally have a far more narrow range of attractive long-term economic outcomes.

Margin of safety still matters for the businesses with durable advantages but -- at the very least -- just a bit less.

I have no idea whether the more optimistic or pessimistic views of Apple's future prospects will turn out to be correct.

All I know is it's better to not be reliant on a favorable outcome to justify the price that is paid.

Instead, better to pay a price that's low enough to provide an attractive investment result even if nothing great happens with the business itself (and even accounts for some of the worst business outcomes).

There'll be no complaints if the business does surprisingly well.

Not complex, but the difficulty can arise out of the necessity for inaction -- sometimes for extended periods of time with the risk being not owning something sensible, or owning too little of something sensible -- until the right margin of safety emerges; it can arise out of the necessity to wait until there is an opportunity to buy only what's understood well; it can arise out of not knowing when to act decisively; it can arise out of thinking you understand something better than you actually do. It is balancing things like this that becomes the challenge. If it were just down to the numbers and a compelling "story" the investment process would be a whole lot easier.

"A lot of people with high IQs are terrible investors because they've got terrible temperaments. And that is why we say that having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success." - Charlie Munger in Kiplinger

It's the patience and discipline (to wait for the right price) followed by decisive action (when that price finally becomes available) and sticking to what you truly know well.
(Try to understand three hundred different businesses well, and the result will likely be understanding none of them well.)

It's less about brilliant insight, more about the right temperament and, of course, the ability to judge business economics well, and knowing what to pay for those economics.

This all depends on a realistic self-appraisal of individual limitations and strengths.

"A money manager with an IQ of 160 and thinks it's 180 will kill you," he said. "Going with a money manager with an IQ of 130 who thinks it's 125 could serve you well." - Charlie Munger in San Francisco Business Times

"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger's 1998 speech to the Foundation Financial Officers Group

Highly capable individuals with optimistic self-appraisals are more likely to get into trouble investing even if they happen to have all the other necessary characteristics and skills going for them.

It's knowing what you really know and avoiding the pitfalls of overconfidence.

Some will no doubt underestimate this.

Adam

Bloomberg: Apple Raises $ 17 billion in Record Corporate Bond Sale

Long positions in AAPL and MSFT established at much lower than recent prices

* These low cost funds should eventually lead to more acquisitions and maybe even some incremental investments (capital expenditures, new business ventures, etc.) once animal spirits return with greater force. Who knows when but, sooner or later, it generally comes back.
** With 3 month LIBOR at current levels for the variable portion.
*** It was not just tech stocks that were expensive, even if it was their valuations that were the most extreme. Coca-Cola (KO) and General Electric (GE) are just two examples of non-tech stocks that had extraordinarily high valuations.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Investor Overconfidence

Roughly a year ago, Fidelity released a poll indicating that 91% of their "active investors" expect to equal or beat the returns of the stock market over the next year.

More specifically, 62% apparently expected to do better than the market and 29% expected to match market performance.

So only 9% expected to do worse.

Well, maybe Fidelity has an exceptional group of investors compared to the average but, more likely, this is just another example of investor overconfidence. Now, it's certainly possible quite a few might do just fine over a shorter time frame, but there is just overwhelming evidence that most investors do rather not at all well against the stock market over the longer haul. From this paper by Professor Terrance Odean and his colleague Professor Brad Barber:

"The majority of the empirical evidence indicates that individual investors, in aggregate, earn poor long-run returns and would be better off had they invested in a low-cost index fund. This evidence of poor performance is particularly compelling when we include transaction costs (e.g., commissions, bid-ask spreads, market impact, and transaction taxes). While transaction costs are an important component of the shortfall, a second component is the poor security selection ability of individual investors documented in many studies that we reviewed in the prior section. These observations lead one to wonder why investors trade so much and to their detriment."

This doesn't just apply to individual investors, of course.*

"Most people think they can find managers who can outperform, but most people are wrong. I will say that 85 percent to 90 percent of managers fail to match their benchmarks. Because managers have fees and incur transaction costs, you know that in the aggregate they are deleting value." - Jack Meyer, former President and CEO of the Harvard Management Company from 1990 to 2005, commenting on investment managers

"Of the 355 equity funds in 1970, fully 233 of those funds--almost two thirds--have gone out of business. Only 24 outpaced the market by more than one percentage point a year--one out of every 14. Let's face it: These are terrible odds!." - John Bogle in The Little Book of Common Sense Investing
(This quote, and others from the book, can be found here.)

"The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors." - From The Motley Fool

The Fidelity study is just another good example of how overconfidence impacts investor behavior and results. In a separate paper, also by Professor Odean and Professor Barber, adds this thought:

"Active investment strategies will underperform passive investment strategies. Overconfident investors will overestimate the value of their private information, causing them to trade too actively and, consequently, to earn below-average returns."

The Fidelity study also indicated that roughly two-thirds claimed they had matched or outperformed over the past twelve months; 80% claimed they had done the same the year before.

This MSN Money article rightfully compares these results to surveys of driving ability that reveal people are often hopelessly optimistic about their own driving skills. Well, it's not much different for professionals. I've referenced this Charlie Munger quote before but it is relevant because:

"...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 speaking to Foundation Financial Officers in 1998

He also later added...

"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose..." - Charlie Munger speaking to Foundation Financial Officers in 1998

Part of the problem is that some judge, inadvertently or not, that they've performed better than they have in reality; that an objective comparison of returns produced by all positions held in all accounts over time to an appropriate index would reveal lesser results. The MSN Money article makes the point that "there is a difference between judgmental performance -- what you think you gained -- and actual performance," with the result being participants not necessarily measuring themselves objectively.

More from the article:

"...investors, when asked about performance, focused on winning trades to prove their ability to deliver strong returns in the future."

As an example, here's just one possible scenario among many. An investor may choose to ignore or at least underweigh the losers and underperformers in a portfolio when assessing their own performance. Let's say one part of a portfolio has recently tripled in value, while several earlier investments or trades went sour. Well, the actual return is naturally the combined results. Yet that investor might -- in what he or she thinks is a well-intentioned attempt to objectively gauge their performance -- decide to weigh more heavily a recent big win (or set of wins) while choosing to treat earlier losses as an anomaly; as just some reflection of past errors or maybe bad luck that's unlikely to be repeated.

Well, that might make for a pleasant rationalization, and it is certainly possible that lessons have been learned, but you can't just arbitrarily ignore certain results and still make a sound judgment.

My point is that, while some might expect otherwise, it's not always easy to be objective when measuring one's own performance.

"The first principle is that you must not fool yourself, and you are the easiest person to fool." - Richard Feynman

So, in a detached and unbiased manner, the entire investment portfolio over time needs to be measured against an appropriate index. Results shouldn't be partitioned into separate "mental accounts" or financial buckets (a speculative vs investment account, for example). This mistake wouldn't be difficult to avoid if behavioral biases didn't come into play.

In the MSN Money article, Professor Terrance Odean added this:

"You are talking about active, engaged people who wouldn't be spending time at the trading summit or webcast -- who wouldn't be trading 36 or more times a year -- if they didn't think they were above-average investors," he said. Even if they are not better than average, they pretty much have to believe they are just in order to do what they are doing, to be active investors."

It's worth mentioning that results over very short time frames don't reveal much. A year or two is just too short to gauge relative performance.

"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

In addition, how much risk was taken needs to be considered even if risk happens to be far less easy to quantify than returns (and, of course, beta is not a meaningful measure of risk). That it is difficult to quantify makes it no less relevant. So risk-adjusted performance needs to be objectively measured over longer time frames.

The being objective part is just harder than some might assume.

It's also worth pointing out that there is plenty of evidence that many market participants do their buying and selling at just the wrong time.**

Unfortunately, too many investors buy when stocks are generally expensive (when the outlook is rosiest and the good times seem likely to continue, indefinitely). They also tend to sell under the opposite conditions. This happens in a remarkably reliable manner. Many stocks were being bought with high confidence in the late 1990s when expensive by any fundamental measure. In contrast, once many individual securities -- if not the market as a whole -- became rather cheap during the financial crisis (and after), interest in purchasing equities became quite low.

As always, it's about buying what you understand when cheap (at a discount to conservative value) and being realistic about limits and strengths.

Overconfidence destroys risk-adjusted returns in the long run.

Index funds certainly do make sense for many investors. Still, there are those who seem to take the wisdom of owning index funds to another extreme. They don't just suggest it is very difficult to do better than a market as a whole; they go further and seem to imply or assert outright it's effectively not possible to do so.

Well, those that think this way are conveniently ignoring things like what Buffett wrote in The Superinvestors of Graham-and-Doddsville and his own long-term track record. The list of investors with a long enough track record of outperformance may be a short one, but it's certainly not non-existent.

Buffett himself has expressed support for the wisdom of owning index funds as a way to gain exposure to equities.

"Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals." - From the 1996 Berkshire Hathaway Shareholder Letter

For many long-term investors, low cost, not often traded, index funds can be a sensible approach. Yet, that reality doesn't logically lead to the conclusion no investors would be better off buying individual equities. It's knowing one's own limits and abilities.

"By periodically investing in an index fund...the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb.

On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you." - Warren Buffett in the 1993 Berkshire Hathaway Shareholder Letter

I've said before that it's not likely, over the long haul, for many investors to do better than low cost index funds. Yet there's a big difference between not possible and not likely.

Again, maybe Fidelity has an exceptional group of investors performance-wise compared to the average. Otherwise, it's arithmetically tough to see how that underperformance by the 9% could absorb the outperformance achieved by the 62%.

Adam

Related posts:
Investors are Often Their Own Worst Enemy, Part II
Investors are Often Their Own Worst Enemy
The Illusion of Skill
The Illusion of Control
Charlie Munger on LTCM & Overconfidence
When Genius Failed...Again

* John Bogle wrote the following back in 2007: "The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it's likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years...well, there's no data (yet!) on that!

But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index."
** According to Vanguard founder John Bogle, from 1984 to 2002 the average mutual fund delivered a 9.3% annual return compared to the S&P 500's return of 12.2% a year. Even worse, during that same period the average fund investor, according to DALBAR, earned just 2.6% a year.
(The average fund investor does much worse largely due to ill-timed buy/sell decisions and fund selection. In other words, a timing penalty and a selection penalty. Bogle adds why he thinks the DALBAR study might actually overstate the annual returns. See his explanation under the Is the DALBAR Study Accurate? section for more details.)
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.