Successful Investing Expects the Unexpected And The Berkshire Hathaway Solution - Weekly Blog # 722

 

Mike Lipper’s Monday Morning Musings

Successful Investing Expects the Unexpected

And The Berkshire Hathaway Solution

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

This was the week that demonstrated that successful investing is an artform, not a science. Most professional investors entered the week secure in their certified knowledge of investment accounting and regulations. These are essential, but insufficient to avoid losses and capture gains from unexpected changes. An understanding of history, particularly military history, is a very useful tool. Additionally, an understanding of the behavior of beneficiaries of large wealth is also helpful in managing both personal and other accounts.

In the US Marine Corps, whenever possible, each major amphibious landing conducts dress rehearsals. Hitler did even more, he tested his air force and underground “fifth column” tactics and equipment in the Spanish Civil War, which prepared his forces for their “blitzkrieg” attack on the Western front. I find it interesting to compare the personalities of Hitler and Putin. Both increasingly became more isolated from their associates, leading to personalized decision making rather than a more controlled group analysis. The picture that was released showing a meeting with Macron and others at a very elongated table is a sign of his isolation. His mental condition led to the false historical positions in Putin’s speech that started his troops moving. 

The history of US retreats from Vietnam, the Middle East, and Afghanistan, encouraged his view. The view that US and Western European countries would not quickly and strenuously defend against his restoration of the old Soviet borders. None of these analyses are taught in CFA classes or law schools. Thus, the investment community was largely unprepared for the critical change to the real environment we faced this weekend. 

My fellow analysts, in response to the needs of their marketeers, have become scribes of reported results and near-term rumors, where predictions are largely extrapolations of present trends. Rarely are there any predictions of trend reversals, nor the identification of new competitors. Most importantly, they rarely focus on the attitudinal changes of beneficiaries of critical assets.

Probable Changes Coming to Berkshire Hathaway

I have been taken to task concerning my expressed view that after the “saintly investment lives of Warren Buffett, Charlie Munger, and many of their 80 or so operating officers are over, there will likely be a move to breakup Berkshire.  Analysts are thus violating one of the tenants of sound advice, which is to predict outcomes, whether favorable or not.

Berkshire is one of the largest holdings in our family accounts and it has produced very gratifying results for many years. Nevertheless, I perceive a dramatic change in the shareholder population on the horizon. I am extremely grateful that the present management has run the company for the beneficiaries of the present shareholders, rather than generating assets for their own consumption, unlike most public companies.

I suspect that those readers of this blog that have experienced asset transfers between generations and have noted a largely consistent pattern, beneficiaries failing to retain the older generations’ investment advisors and/or investment philosophies. After years of waiting to make their own decisions with “their” money, the first thing they do is sell out of their inheritance. They might be a bit slower if they realized there would be a materially higher valuation placed of their inheritance.

Messrs. Buffett and Munger have built a portfolio of assets with different risks and rewards based on the type of economy. I firmly believe numerous operational and investment assets could be sold to higher bidders, increasing leverage and assuming more risk. Charlie Munger has said that not every asset they own is likely to be worth their carrying value at a particular time. To the extent that individual assets are hedges against other assets, a one-time complete breakup of the company would destroy the hedging value laboriously built into the portfolio. (I am comfortable with this portfolio approach. As an investor in mutual funds, I judge their value based on their overall performance patterns over time. By definition, funds never do as well as their best position or as badly as their worst.)

 In the future, I expect a significant portion of Berkshire stock to shift to new owners. Many of the new owners would likely support an attempt to convert their wonderful inheritance into a bigger pile, showing their departed grantors that the new owners are brighter than those that gifted the money. I DO NOT SUPPORT A BREAKUP STRATEGY, but that will not preclude it from happening.

There is an intermediate strategy which could be a better approach. In the past, Berkshire has not been copied by other companies in the past in advised other investors on how they do things. In terms of of operations and investment and how they manage a holding company to generate free cash flow and tax assets. I am hopeful the same kind of ingenuity that produced the $147 billion “float” can be applied to the company. This might create a holding company like Allegheny Corp, in which I own a few shares. Allegheny owns both minority, majority and 100% ownership in a number very diversified companies, with a goal of building book value. Whether we like it or not, youth will control Berkshire at some point, and we need to recognize it. 

Weekly View

While it is possible there will soon be an end to hostilities, I don’t expect we will see a strengthened position of the Western allies, both in terms of Russia and China. We need to be prepared for problems arising out our past weaknesses.     

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

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Contact author for limited redistribution permission.

We are Progressing - Weekly Blog # 721

 

Mike Lipper’s Monday Morning Musings

We are Progressing

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

                  

This is a blog on investing and is not intended to express any political views. Every single action we take, including taking no action, is an action. Every single action we take has less of a future impact for those we care for emotionally or legally, be they the next moment, day, week, month, year, or the rest of our lives. With that thought in mind, my focus is on the indefinite time periods for those we hold ourselves responsible.

This blog is focused on an investment period measured in years, comprising multiple market cycles. In sharing my thoughts, I am very conscious that humility is the only guarantee in investing. There will be periods of elation and depression as we travel through the various phases of market cycles.

Point of Departure

I believe markets move within their own cycles. I find it useful to measure from peak to trough for the styles of investing which identify most of what we do. In the absence of detailed knowledge concerning the structure of an investment account, I use three major stock indices for the US equity market. The NASDAQ Composite Index, which topped out last November, contains future oriented securities valued for their growth potential. The S&P 500 Index, which peaked on the 4th of January, is meant to contain the 500 largest and most liquid US stocks traded in the US. The S&P 500 Index is representative of the bulk of long-term US stock investments and is often used by institutions to represent “the market’. The Dow Jones Industrial Average (DJIA), which topped out on the first day of 2022, is a selection of the 30 most representative stocks.

Where Are We?

As a working assumption I believe most US equities have topped out for this phase. What phase we have entered is the question investors are asking. The choices are:

• A minor fall to a support level like the Dow Jones Transportation Index, a key component of the oldest market timing model, the Dow Theory. 
• The NASDAQ Composite Index, which fell beyond the 10% correction level used by the press.
• The S&P 500 Index, which is close to entering a correction phase, to be followed by the DJIA.

As we manage long-term money, which has long-term payout needs measured in lifetimes, I believe we have entered a downward slope with periodic upward trading opportunities. (57% of NYSE stocks and 61% of NASDAQ stocks fell last week.) Hardest hit were growth funds, with the T. Rowe Price Growth Fund falling -4.38%, the worst of the 25 largest growth funds. 

Focus

Instead of focusing on trading opportunities, I am focused on the likely investment opportunities in the subsequent rise in the market after the valley. To get to the happy hunting ground we will have to deal with expected problems. In time order: Ukraine, inflation, and Long COVID.

Ukraine

As is usually the case, the media and politicians are focused on the wrong things. First, the Russian Army has a significant number of conscripts due to return to civilian life who are not battle trained. They would suffer significant casualties, which would not go down well within Russia. If the Russians invade, they are likely to suffer casualties caused by a well-armed and trained army and volunteers. They have a lot to fight for, as shown below:

• The Largest proven recoverable Uranium resources in Europe
• 2nd largest explored Manganese ore reserves in the world
• 3rd largest exporter of iron ore
• 4th largest array of natural gas pipelines
• 8th largest number of installed nuclear plants

To an important degree, Putin has already accomplished his goal of weakening NATO by showing the unwillingness of Germany to take up arms, followed by Italy and a weak US response. So far, the only negative from Putin’s point of view is the push by Sweden’s second largest political party to join NATO.

Inflation

From the White House’s viewpoint, it is pleased the market is doing the job that the Fed was meant to do. The markets most sensitive to short-term inflation are the commodities markets, which are pricing commodities higher in the near-term than the longer-term. Members of Congress are preventing the White House from adding to the problem, by resisting an increase in money supply growth. 

A study of 19 recorded pandemics over 700 years shows real interest rates falling in all cases. However, a complete solution to the supply chain issues has several hurdles to overcome and is unlikely to be solved before the next Presidential election. These include: 

• A shrinking number of petroleum refineries, from 301 in 1982 to 124 today.
• The absence of new mineral production and severely restricted new mine and pipeline volumes.
• Fewer skilled workers and supervisors returning to the workplace due to Long-COVID. 

Long COVID

Long COVID is the inability of some workers to return to the workforce due to PASC symptoms, which stands for Post-Acute Sequalae of SARS COVID. (Cumberland Advisory has a good blog on their panel discussion on the subject.) One study predicts between 10 and 20% of those who get COVID will get the Long version. One must expect other pandemics in the future, and we have not yet come to an understanding the best way to reduce their damage.

Investment Shopping List

While it may be a long-time before a terminal bottom is hit, and more importantly recognized, one should start building a shopping list. There are two categories that appear to be worth examining: common denominators and the not yet dead that are still working.

Common Denominators

At times it is difficult to pick a potential winner out of a crowded sector. I have followed two approaches on this issue. 

1. The first is to find a sound sector manager or fund to make individual choices. The problem is that manager’s need to diversify, resulting in too many choices. The second is to find one or two stocks that capture most of the future expected benefits. Two common denominator stocks in the financial services industry are Moody’s and S&P Global (already owned). Internal developments and acquisitions should capture additional business. These are to be put on the hunting list and should not be bought today, they are already more than adequately priced.
2. The second approach is to look at the non-winners in the current market to see if the sick/dying corpses have elements that will blossom in a new market. I use the multiple of current price to sales as a primary initial filter. Four large companies that could have something to value, in order of their price/sales ratios, are: 

Corning (2.55x)

Intel (2.49x)

IBM (2.15x)

HP Enterprise (0.78x)

HP Inc (0.64x)

I am sure that there are others, and they should be researched.

Subscribers: Please share your thoughts and suggestions. We unfortunately will have some time before we select new holdings   to new heights. However, it takes a lot of time to get to know new names and get comfortable with them, after what may be an unhappy period. 

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

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A. Michael Lipper, CFA

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Building Long-Term Investment Portfolios - Weekly Blog # 720

 

Mike Lipper’s Monday Morning Musings

Building Long-Term Investment Portfolios

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

After the Valley

We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.

Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.

I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:

Goldman Sachs - Expect lower returns for market indices

T. Rowe Price - Global growth is primarily dependent on China

GMO Capital - Stocks are expensive and resources are cheap

Merrill Lynch - Late stages of a maturing bull market

Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.

Cyclical or Structural Decline?

A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected. 

The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019. 

One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.

Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.

Four Portfolio Approaches

Large-Caps

Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services. 

Small-Caps

In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.

1. They have a higher rate of business failure, with the larger ones being rescued.
2. Some of the better small-caps are bought by larger companies, cutting off their price growth.
3. Lack of media and analyst coverage leads to greater volatility.
4. They have an absence of critical talent at stress times.

“Barbell”

A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.

Idiosyncratic Selection

Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:

• Best Product/Service
• Top Market Share or Fastest Growing
• Great CEO (Replaceability risk)
• Lack of Debt or Too much Cash
• Institutionally Owned (Liquidity risk)
• High earnings growth (Unsustainable)
• Smart Ownership
• Large customer base (High renewal potential unless market changes)
• Well-connected within industry and government (Things change)
• Estate and other ownership issues
• Speaks ESG language (Plus or minus?)
• Never moved headquarters
• Strong social connections 
• Ownership too concentrated by age and type of investor
• Etc, etc, etc.

Career Investing

Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.

What are your thoughts 

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

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Changing Focus in a Changing World - Weekly Blog # 719

 

Mike Lipper’s Monday Morning Musings

Changing Focus in a Changing World

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Changing Focus

Securities analysts should come with two perspectives. The majority attempt to read the current minutiae of what companies are saying, with the goal of assessing the current price and the probability of relatively short-term future prices. The second perspective, rarely produced for public or client consumption, eventually pays bigger rewards when correct. 

For some time, this blog has highlighted the relatively unreported negatives concerning the current optimistic outlook. Entering 2022, there are more comments about risks and possible recessions, which while still in the minority of published opinion, has increased in coverage. At this point there are enough bearish comments, so I can move on to the much tougher challenge of finding reasons to be optimistic. The eventual major stock and bond market decline is inevitable, although I cannot identify the time and headlines that will label the decline. Furthermore, I cannot stipulate the length of the bear market, which is normally a function of what owners do, not what issuers do. In other words, from the current lofty levels I am beginning to look across the valley of disappointment to the beginnings of the next expansion. 

I look forward to learning the views of subscribers, both concerning the down phase and the recovery.

Changing Environment 

The future will contain a multitude of changes, many small, but a few unexpected by most will verge on being seismic. At some point in many developed countries, the growing size of government debt owed to non-citizens will be too large. Not only will foreigners refuse to buy more, but they are also likely to push for debt repayment, not rollovers. 

For many Central banks and commercial financial institutions, US debt is a prized asset. However, Mae West may finally be wrong in that “too much of a good thing is wonderful”. In 1990 the Federal Debt totaled $3 Trillion, now in under half of a lifetime it is $30 trillion. Politicians of both parties are responsible for this growth in our children’s and grandchildren’s debt. Interestingly, 35 of 50 states require balanced state budgets. (One can examine the financial health of the 15 states that don’t have this restriction, comparing local crime and inflation.)  While the growing debt is deplorable, it is probably a good indicator of how the government meets its other responsibilities. (Some houses never have a single broken window.)

Looking at the implication of the growing debt and its likely impact on the investment environment in 30 years. The debt will impact our children’s assets and the future value of what our grandchildren inherit. It would be prudent to expect taxes of all sorts to increase. Increased taxes will lower the reported earnings of companies and will probably delay the dividend increases the third generation may be living on. Will it likely lead to lower price/earnings ratios? (Since the 1950s we have generally benefited from rising earnings multiples.)

There are at least two other changes to our investment environment, both positive if one’s portfolio is properly positioned. The first is that winning companies and institutions, no matter what they do, will make progress by improving customer service. Because technology will likely continue to lower the costs to manufacture and transport, the winners will have the attitude of successful service companies.

We are already seeing the third trend that is going global. Year-to-date figures show the US market declining more than 5%, while Brazil is up +10%, Greece +8.5%, South Africa +6%, and Chile +6%. Five other countries have positive equity markets. We are also seeing positive fund flows into Western Europe, Japan, and Emerging Markets. This is probably not a short-term phenomenon. While one can understand a certain reluctance to disclose critical information in patent applications, the number of patents granted suggests a large amount of technology innovation is taking place outside the US. The percentages of patents awarded in 2021 was: China 49, Japan 15, South Korea 11, US 10, and Europe 8.

Changing Companies

Many companies continually evolve, some more dramatically than others. As my primary focus is financial companies, I see some making changes that should impact earnings patterns in the future. Goldman Sachs (*) is developing a retail banking base to fund their investment banking activities. It is my speculation that when Buffett and Munger are no longer involved with Berkshire Hathaway (*), shareholders will own more than one stock certificate. Over time it is reasonable to assume a number of their activities could generate higher stock prices if separated. I also suspect that if the Fed, FDIC, and Treasury come under more restrictive management, a number of banks will split their activities requiring a bank license, placing the more profitable businesses in another company. Watch JP Morgan Chase (*) for such a move within ten years. The financial sector may initiate dramatic changes in how they manage their human relations and work from home activities.

(*) Owned in managed accounts or personal accounts.

Changing Investors

The current effort of some governments to regulate an increasing amount of corporate activity through regulatory bodies will drive more investment into private companies. There is already some level of private market transactions, which will increase. NASDAQ (*) has been active in this, as have a number of brokerage firms and banks. This drive may well lead to more cross border transactions. In dealing with private companies, valuations are often based on verifiable sales data, which includes a price/sales comparison. There is a lot of room for such transactions. For example, the P/S ratio for the Russell 1000 Growth is 5.12X, with the MSCI World ex US Small Cap being 1.05X. 

In terms of investment sophistication, there are private investors capable of protecting themselves as smaller institutional investors. There are times where not being public is better for both the company and its investors. In many cases these investors have entered a second career as a supervisor or confidant to multi-generational family assets.

Question: In your thinking about the future, what changes are you expecting and how will you handle them?

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.