Sunday, February 26, 2012

I am Happy I Bought More Berkshire Hathaway


I do not have buyer's remorse from adding more shares of Berkshire Hathaway (NYSE: BRK-A), currently priced at about $120,000 per share, to my private financial services fund. At the end of each year I make an effort to invest any spare cash that has accumulated in this portfolio; Berkshire was one of the three stocks I purchased at that time.

The ‘Buffett Discount’

For the last few years, along with my wife, one of my sons and good friends, I have attended the Berkshire Hathaway shareholder meeting in Omaha, one of the world’s largest such gatherings. After last year’s meeting, I wrote about the “Buffett Discount” in my blog entitled Observations from Omaha. Normally, stock prices pay a premium for a history of successful management, sometimes too much. In my opinion, last year the reverse was true. The uncertainties as to who would, in time, replace Warren Buffett and Charlie Munger, weighed on the price of the shares. This was a concern for a number of years, but last year became a headline event when the presumed CEO replacement left the company under trying circumstances.

The last Saturday in February is the usual time that Berkshire publishes its annual report, including a much anticipated letter from Mr. Buffett. On Saturday, like many portfolio managers and other investors, I devoted a number of hours poring over the document. While there was additional, welcome, detail on the progress of the company, there was very little of new information that would have changed my mind at year end, when I decided to increase our investment. What was news was the disclosure that the next CEO and two backups is known to the board, but not yet revealed to the other shareholders. For some investors this may close the Buffett discount, but I was confident that it would happen one way or another relatively soon.

My rationale for buying more

Our most recent purchase of BRK-A is already up 4.6%. (I mention this to our blog community and fellow shareholders only because we bought in the midst of what was considered by many as a troubling stock market.) Below is a brief outline of my thinking.

  1. We bought at a small (15%) premium to a very much understated book value. The company itself has a policy of only paying 110% of book when buying back stock. The book value of Berkshire's operating assets is essentially its purchase price, but after acquisition earnings. As many of these acquisitions were made years ago and at bargain prices, I am guessing a multiple of book is a more appropriate measure. (This might suggest that the return on investment would be lower, based on the higher augmented book value.)

  2. The Buffett discount mentioned in my prior Berkshire blog is being addressed. There is now an undisclosed CEO, with two backups in reserve. In addition, two value-focused investment managers have been hired.

  3. The five largest operating subsidiaries are reporting record operating income.

  4. “Float” production remains ample, aided by nine years of underwriting profits (even if there is an occasional loss year).

  5. Recognition of past mistakes is acknowledged by management, both in terms of acquisitions and portfolio decisions. This is comforting compared with many CEOs and portfolio managers.

  6. Berkshire benefits from others providing leverage for its regulated activities. Operationally, Berkshire is leveraged to housing, which appears to be getting better.

  7. As the company is primarily US-based, after much of its US business is improving, our multi-year outlook is encouraging.

  8. Averaging up at a lower valuation is generally a good thing.

Do you own BRK?

If you are a shareholder of Berkshire Hathaway with an interesting experience, I would like to hear from you by email.

Did you miss Mike Lipper’s Blog last week? Click here to read.

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Sunday, February 19, 2012

Chinese to Buy Euro Debt, plus

  • Chinese Exports
  • A Signal of an Expected Turn in the US Economy?
  • Investment Implications of “Warehousing”
  • Observing George Washington’s Birthday

Not an act of charity

The recent headlines that the Chinese government will support the euro by purchasing bonds of various European entities brought cheers to European markets as well as to those in the US. The cheers, however, missed the point. The Chinese government was not conducting an act of charity for the “old world.”

European banks have been the largest single international source of loans to Asian countries and companies, particularly those that have been labeled “emerging market” borrowers. Many of these loans are coming up to repayment dates. Rolling over loans is a normal part of banking when times are normal. Loans are not rolled over when banks are contracting their loan books. In 2011, approximately 40% of loans globally were for refinancing existing debt, and I expect that it may be a higher percentage in the surging emerging markets world. The Asian stock markets declined recently not because their sales and earnings were in the same sort of decline as was occurring in Europe, but because of the fear that in their need for capital, the European banks will retreat from lending to the region. If these loans were not rolled over, a number of Asian economies and companies would have to markedly retrench. An economic contraction elsewhere in Asia can undermine Chinese exports to the region. Already China is suffering from the contraction in the largest market for its exports, Europe.

Thus, the Chinese government is not practicing a form of charity, but following its own self-interest. The move is somewhat like the US government’s foreign and military aid loans. Each of them carries requirements that the credits so extended must be utilized in purchasing various goods and services from the US. These purchases have been an important source of revenue to our defense industries and our farm communities.

Problems in Asia?

The need on the part of the Chinese government to take these actions should first be seen as a flashing yellow light as to potential economic problems in Asia, the geographical center for growth for the rest of the world. Because of its current and future potential growth, I have been an advocate of North American, European, and Latin American investors upping their exposure to Asian securities to levels that approximate the Asian share of the growth of global GDP. Nevertheless, I view these statements of support for the euro as smart by the Chinese, but also as a warning that they see that their own growth can be curtailed by Europe’s problems. Thus, while Asian exposures in many portfolios should be enhanced, those investors who are now trying to play catch-up ball should move in a more measured pace.

Do the stock prices of consumer discretionary companies going up confirm an expected turn in the US economy?

Many believe that the US economy will become more robust in the near-term future and investors in consumer discretionary stocks will be richly rewarded. I do not think that is the only, or even a correct, interpretation of the rising prices for consumer discretionary stocks. The stocks that were rising in January were those with large market-capitalizations. However, in January, my old firm now known as Lipper, Inc., estimated that there was $8.4 billion net withdrawals from Large-cap Core and Large-cap Value funds. (I believe most of these net redemptions were in effect, completions of investment programs for long-term investors shifting their capital base due to voluntary or involuntary retirements.) In the same period, combining the flows into Small and Mid-cap Value and Core funds, produced net redemptions below $1 billion. In contrast to these trends, for ETFs in January there was a net inflow into Large Value and Core funds of $ 1.4 billion, and $ 2.2 billion in the Small and Mid-cap range of ETFs. The buyers of ETFs tend to have more of a trading orientation than the longer-term investment orientation of most mutual fund investors. To the ETF traders, liquidity is of greater importance. Both hedge funds and others that are hedging portfolios find the momentary liquidity of ETFs particularly inviting.

Investment implications of “warehousing”

What I really think is happening in many consumer discretionary stocks is that the buyers are less interested in the long-term investment value in these stocks than the ability to put sizeable amounts of money into them. In effect, they are warehousing their money that will get some market returns, while they are waiting to make more aggressive investments. We have seen similar techniques over the decades by somewhat cautious, or if you will, “chicken investors.”

The investment implication of an increase in “warehousing’ is that there is more capital available for aggressive investing than meets the eye. In some of these warehouse stocks there is risk if too many of these “chicken investors” move out at once, even when the companies are reporting good results.

Observing George Washington’s birthday

Saturday night, Ruth and I attended a wonderful dinner celebrating the 280th birthday of our first, and for many of us our greatest President, George Washington. The dinner was held at his privately restored estate, Mount Vernon. An exhibit devoted to Martha Washington's renowned cooking skills was located in the Visitors' Center. In terms of demanding attention to detail, one gets the sense that she was as formidable as her husband. Mrs. Washington’s attention to detail triggers my thinking about getting investment insight out of news headlines.

Did you miss Mike Lipper’s Blog last week, Click here to read.

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Sunday, February 12, 2012

Two Blogs from Shanghai

Investment lessons from this year’s Super Bowl

My recent trip to Hong Kong, Singapore and Shanghai stimulated thinking and reading about investing in China. This was my first visit to Asia during a Super Bowl, and this blog post will focus on notes made while watching the game on a Chinese-language station. The second of my two blogs from Shanghai summarizes my observations regarding investing in China.

As some of the members of this blog community know, I have the privilege to manage the defined contribution money for the National Football League and the Players Association. Thus, watching the Super Bowl is something of a pleasurable requirement wherever I happen to be. This year I found that viewers in Shanghai were treated to the same excellent camera work from the same network that many of you saw.

Lessons for the team owners

In terms of the league activities, the NFL owners operate through a series of committees. (This is an excellent example of successful self-regulation, which in the past has worked quite well for the financial community.) The Competition Committee develops the rules of the game that is fair for all thirty-two teams and their players, with a focus on what appeals to their fans, (both in the stadiums and in front of their television sets). One of the folklores in the league is that on any given game day, any team can beat any other team. Even with this principle, before the season began there was not a single expert that believed that the eventual winner of the Super Bowl would be the New York Giants. Through the complexities of the game schedules, the eventual winner got to play in its finest game of the year. (That should be some consolation to the chair of the committee, who just happens to be the main owner of the great New England Patriots, who almost won.)

For many years the team owners have been trying to export the game beyond the US. While there were a few advertisements on the Chinese language station, there were a lot fewer than what we would have received at home. The fewer ads financially supported a much-worked single commentator. Watching from Shanghai, I could see how often nothing was happening on the field. These programming gaps were filled I am sure, in the home market. My conclusion from this observation is that the league has a big marketing effort ahead of it if it wants to build a fan base in Shanghai with its twenty million-plus population.

Lessons for the team cities

Teams often take on the attitudes and personalities of the cities they call home. Boston was founded on an idea, in this case, religious freedom. Residents of the city became the intellectual spur that led to the American Revolution. The first signer of the Declaration of Independence was the governor of the state. Later on, Boston would become famous for developing trust law and acting conservatively for others. Its football team, the New England Patriots (originally the Boston Patriots), played largely to these tunes, with finely executed, and generally conservatively managed plays.

New York was founded by the Dutch and their commercial law and practices (think “Tulip Bulb Mania”) as a site to promote competitive trading. The establishment of the United States with the Declaration of Independence hung in the balance, as many New Yorkers had conflicting viewpoints as to whether to sign the document or not. Later, the marketplace competition gave many the impression that New Yorkers were sharp dealers and could be rough. My guess is that only in New York could our greatest securities markets flourish. Thus in character, the combination of a very strong front line, very aggressive backs, and a quarterback who was not afraid to gamble, are representative of what the rest of the world thinks of New York.

Lessons for investors

Sometimes perfection is not enough. In the game, Tom Brady established a record of sixteen consecutive passes with amazing accuracy; often hitting well-defended receivers. In terms of the ability to successfully execute conservative plays, I believe the Patriots were the best on Sunday, if not most days of the year. But they lost to a more aggressive team that forced things to happen. In the final play of the game when the Patriots could have scored the winning touchdown, their talented quarterback threw a long "Hail Mary" pass into the end zone, with two potential receivers who were guarded by at least four defenders. The Patriots just ran out of time to show their superiority.

As an investor, the lesson I take out of watching the game is that one can execute flawlessly, but still lose. In the competitive world of performance, measured in finite periods of the calendar, one can run out of time. The last day or trade can make the year. At times, one can win by forcing the competition to make mistakes including going out of their normal patterns.

In this year’s Super Bowl, no one came out as a loser, all played well, including the officials and the competition committee.

To read the second of my two blogs from Shanghai, click here.

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The Second of Two Blogs from Shanghai

Note: The first of my two blogs from Shanghai notes my experience and lessons from watching the Super Bowl via a Chinese telecast.

My assumptions about China

  1. We cannot escape China. In a world of dynamic marketplaces, China or rumors about China produce incremental supply and demand for most key products and services, including raw materials, scrap, agricultural products, US Treasuries, currencies, intellectual property and military activities. The perceived size of the Chinese increments is enough to move markets. In brief, as China goes so does most of the rest of the world.

  2. There will be growth in Chinese due to its rising standards of living, the continuation of these advances is a political necessity.

  3. There are likely to be crises along the way due to accidents, mistakes, and poorly executed policies. Lives and fortunes will be lost, but most will recover.

  4. China will survive its centrally induced growing pains and will grow stronger.

  5. Guaranteed, we will get some things wrong, but we hope to get most of the big decisions right, perhaps later than some, but ahead of most.

I started the trip to Hong Kong, Singapore, and Shanghai with specific objectives. I visited with various managers we have used in the past and in the present. I found two other managers that bear future consideration. One of them had a good record before retiring and has come back into the game founding a smaller fund; and the other had a great record in the UK and Europe, then shifted to Asia, where he currently has a terrible record. More importantly, I have met a number of people that have very intelligent views of what is happening in parts of Asia and particularly in China. There were also opportunities to invest privately in new start-ups.

The Chinese puzzle

China's imports hold the key to prosperity for many countries. Currently most of the news media focus is on the raw materials imports, ignoring machinery imports and soon to be followed by imports of intellectual property and high value services. Incremental supply and demand for most of the world’s products and services are fueled by domestic Chinese demand.

China is a command society, unlike many dictatorships where the prime motive is enriching its leader. In its own way, China is somewhat mimicking Singapore, with its planned rapid development from a third world country to a powerful first world leader. What I did not fully understand is that the Communist Party is critically aware that its dynasty is only safe from the social disruption that has terminated other dynasties if it can deliver a materially higher standard of living to its people. This is particularly true in the interior cities, which are large and growing. So-called villages have twenty thousand inhabitants. The party is a believer in long training programs for its leaders. The up and coming leaders are well aware of what can go wrong, and are prepared to deal with these problems. They will come up with new tactics to find solutions. For example, as noted in previous blogs, I have been concerned with the desire of the central government to have the major hinterland cities be no more than five travel hours away from a coastal port. I learned on this trip that a railroad is being built through Russian territory that will allow the delivery of goods to Europe in eleven days rather than the twenty-one to twenty-nine days it takes to ship from coastal ports. Further, in the past the low wages in the interior reflected the low presumed productivity. For the last several years this has not been the case. Women returning from coastal jobs bring their better productivity with them.

I have been concerned about the dependency ratio; the number of workers relative to the seniors was declining, as the labor force has peaked out due to the one child per family program. I have been told that it is government policy not to provide good healthcare for the elderly. Further, the authorities are liberalizing the one-child family rules. These changes, plus the willingness to hold a local election in an area of unrest, are examples of the government’s adaptive behavior. In effect, the party is permitting reform followed by readjustment to be followed by further alternating reforms and readjustments. The Twelfth Five-Year Plan, put together by the incoming leadership, focuses on increased productivity, greater energy efficiency through deregulation, and increased transport. The party is well aware that something will go wrong, but they hope to be able to manage it. To me, this is like controlling the conversion of uranium-235 to uranium-238. When there is enough U-238, there can be an atomic explosion. That happens when the quantity reaches critical mass, which is a reasonable fear as China continues its rapid development. The world will watch as its future partially unfolds in Chinese hands.


To protect our investments everywhere and in every form, we have a need to research what is going on in China and to better understand the implications as our assumptions and observations may be wrong.

While we need to regularly read circulated reports and the press (including the central-government controlled China Daily), we also need to include independent sources; e.g., Hugh Peyman and his Research-Works and other experts like Yang Pang.

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Sunday, February 5, 2012

Beware of Future Crowding in US, Emerging and Frontier Markets


The purpose of my blogs is to share musings as how to grapple with long-term investing as distinct from shorter-term trading. Most of the time my focus is endowment-type thinking, be it for my family or supposedly perpetual institutions that have some near-term funding requirements but whose main focus is to maintain the organization forever.

Bearing the above preamble, instead of my normal optimistic views, on a longer-term basis I am getting nervous. This anxiety could be caused by the fact that I am finding too many thoughtful investors have parallel views.

The US Markets

As regular readers of these blogs have learned, I have believed that there was more upside potential than downside risk. Since the beginning of the year we have seen currencies, bonds and stock prices rise. As somewhat expected, the general rise has been led by financials and smaller companies. Much of these moves are recoveries from past declines, nevertheless the following three facts are unnerving for someone not used to so much good market news all at once:

  • The S & P SmallCap 600 index reached an all time new high.

  • The NASDAQ index is at a 11 year high. (Still way below its former peak.)

  • The Dow Jones Industrial Average has risen more than it has in the last 4 years.

These price movements are beginning to attract volume and many politically motivated people are becoming bullish. My problem with all of this is if one extrapolates the January gains achieved in some portfolios, one could start to hear about certain managers delivering at a 100%+ rate! My instinct is that this enthusiastic response will be met with a sudden and sharp decline. If the decline reaches 10% or more, it may allow the late-comers to participate.

Emerging Markets/Frontier Markets

Over the last couple weeks I have been focused on Emerging Markets and Frontier Markets, talking with a number of portfolio managers that have successfully invested in these two markets for many years. What is disconcerting to me is that I am hearing the same comments about various markets which can be summarized below:

  • It will take a long time for corruption in India to subside to the level of other Asian counties.

  • China is a mixed picture of large long-term consumer demand, but with near-term infrastructure hurdles and capital flight, some earned through corrupt practices. The two unanswered questions are when will there be sufficient east-west road and rail traffic to bring a rise in the standard of living to the hinterland cities, and whether the all-controlling government will continue to succeed.

  • Smaller markets are attracting a good bit of interest; e.g., Indonesia is coming into its own with Western firms establishing offices there. The lowering of the high interest rates and the return to investment grade after many years of "junk" grade has been a big boost. There appears to be a short supply of stocks relative to demand.

  • Africa is definitely of interest, with investments going into Ghana and Nigeria. Even local banks are of interest.

The fuel for these markets is coming from Europeans trying to escape the euro and the wealthy Chinese who are quite desperate to get money out of China. There are also negative reasons to invest in these markets; beware that exiting can be more difficult than entering. With all this enthusiasm, caution should be exercised.

Except for the real long-term investor, I would wait for better entry points that are less crowded.

Did you miss Mike Lipper’s Blog last week? Click here to read.

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