Lifetime Investment Views

In last week's post I mentioned the views of Warren Buffett and Charlie Munger at the annual celebration of  Berkshire Hathaway in Omaha: that one should keep on learning over his/her lifetime,  I would suggest everyday. For me investing is an experienced derived art form, thus I believe that investing should be an everyday practice.  Every single day, whether one does or does not make a transaction and/or hold excess cash is an investment decision day. Everyday brings both new information and experiences of oneself or others that should be digested.

With these thoughts, I am trying to figure out what to say to my eldest grand daughter. She is graduating cum laude from William & Mary, the first chartered university in the US. She has had many investment-oriented advantages in her life including going to school outside of her home country and the fact that her father is the investment strategist for a growing asset allocation fund. Nevertheless I feel compelled to lay out some basic views that will help her to become a successful investor throughout her long and productive life.

To recognize that everyone is a gambler

The decision to get out of bed in the morning is based on a belief that the day will produce more good impacts than bad ones. While we have no enforceable guarantees, our experience is what has happened in the past. So we gamble that this is our fate for today. When we cross a street we gamble that everyone will follow both the laws of the land and physics, otherwise we are at risk of loss of life, injury, and property damage. There are many of examples of us taking gambles everyday. I believe that we cannot avoid gambling.

Every gambler believes that there is at least one more opportunity to win. Because we each take the gamble of getting out of bed and crossing the street, we are all optimistic. Some of us more than others. Chuck Jaffe had an interesting column focusing on the recent high of the Dow Jones Industrial Average. 

In the article he quoted an old friend and client of ours the late and sometimes great growth mutual fund manager, Bill Berger. Bill believed or at least said that in the 2040 period the famous benchmark could reach 116,200. The view was based on a mathematical rule that could produce two occurrences of a triple in thirty-two years. Few today would be that optimistic, but the rules of chance do not absolutely rule it out. It would help to start from a depressed level, which will happen sometime in the future. When that happens it would be wise to remember the words of Seth Klarman, a hedge fund manager with a brilliant long-term record. He has said, "Investing, when it looks the easiest, is at its hardest." The payoff from risk-adverse long-term orientation is just that - long-term measured over one or more cycles of looking stupid.

For my grand daughter and many endowments, they need to understand that they will live through many cycles of alternately looking brilliant and then appearing to be stupid. This could be labeled the curse of future orientation which pivots on the externally determined timing of events as well as a normal load of disappointments.

Hurdles

At any given time there will be problems that need to be understood and put into perspective. For example, let me deal with a couple that got my attention this week. 

Margin debt

According to the Wall Street Journal, the dollar level of margin debt is almost equal to its all time high hit in July, 2007, just before the market peaked out in the fall of '07. I noted the level but I am not unduly concerned because the size of the market has grown and some of the borrowing is for non-security investments not tied to stock market prices. Worth watching, but not worrying, yet.

High yield spreads - the canary in the mine?

John Lonski, chief economist of Moody's Capital Market Research is expressing concerns that the revenues of the companies that have issued high yield bonds is sub-par historically when the spread between the yields on these bonds compared to the yields on similar maturities of US Treasuries is historically small. The yield spread normally is a collective view as to the credit quality of the bonds. This dichotomy with concerns of low relative revenue growth could signify a potential problem. Smart stock investors have learned that the movement of bonds can foreshadow stock price moves. Again, in this case I have noted these elements, but I am not unduly concerned. The high yield bond fund of today is yield driven and not as sophisticated as those in the past. I will be concerned when the yields on US treasuries double from current levels.

For my grand daughter the lessons are first, there are always things intelligent people are worried about. Second, most worries need to be put into historical perspective. Third, be most worried when too many people have no worries. Fourth, like the great investors at Berkshire Hathaway^*, as well as good managers like Seth Klamer, use worrying times as buying opportunities and do not be afraid of looking stupid.

^*A position in our fund and personal holdings

Please share with me what investment thoughts are you suggesting to your young investors for the long-term.

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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission

Investment Lessons from Berkshire Hathaway’s Meeting

We have just finished attending the annual gathering of Berkshire Hathaway. My wife and one of my sons joined me for this, in effect, convention of Warren Buffet and Charlie Munger disciples. While the five and one half hour question and answer period was meant to be focused on Berkshire itself, many of the comments could apply to how I manage money and perhaps a number of others who are managers and/or professional personal investors. (I would be happy to communicate with you my personal views on the stock which is owned in my private financial services fund as well as my personal account, if asked.)

The following are phrases and sentences from my notes of the meeting:

Personal rules

-Opportunity costs matter.

-Don't make decisions when tired.

-Stay rational by avoiding the applause of Wall Street, don't become envious.

-You must love something to do well at it (intensity of effort).

-Finding new investments/products is exciting.

-Build on what you know.

-Keep learning, the game of life is everlasting learning.

-You won't win every skirmish.

-If the company does not have an edge then don't play.

-If you have doubts, forget it.

My reaction to these rules is that many of these we have heard before from the two master investors. This time the emphasis on opportunity cost is new. What they are suggesting is that every new purchase needs to be viewed against other opportunities; both within their existing portfolios and other potential buys. In effect, they are bringing forward the concept of relative attractiveness in real world situations as distinct from whether something is attractive regardless of alternatives. The personal rules also suggest their defining discipline that has kept them out of most investment troubles over the last fifty years. They have a broader set of knowledge and senior contacts than most other investment managers and I have. Nevertheless, we try to stay within our areas of knowledge and hopefully competence.

Bubbles

-People reevaluate very fast.

-Capital and the willingness to commit quickly during panics are critical, panics will happen again.

-The future bubbles won't be led by the banks.

-During the building of a bubble, the skeptics look like idiots.

-People get fearful and greedy en masse but confidence returns singularly.

-Secured options now with low rates look unsecured.

-You should always want to accept options, but not give them.  

In looking at Berkshire’s great record, one sees that down markets play a clear role in its long-term superior results. First, because of its perceived quality bias its publicly traded investments and many of its private investments go down less than its peers and in most cases the market. Further, if the decline is the result of a collapsing bubble, Berkshire has been successfully opportunistic and quick to offer to rescue sound businesses that are temporarily cutoff from other capital sources. In exchange for very favorable current income with a “kicker,” the rescued company gets a banner approval from Warren Buffet which is quite reassuring in periods of panics. The ability to perform the rescue at very high current and potential rates of return comes from the rapid approval process and the existence of Berkshire Hathaway’s cash pile. To some degree in putting its winnings in perspective, one should recognize the opportunity costs of preserving cash supply in good times for use during crises. Berkshire has a become a skilled fireman in bringing raging fires under control.   

Stock investing

-Good selection process is not just filling out the boxes.

-Likely to do relatively better in down years.

-Pay up for good businesses.

-It is easier to buy stocks and companies than to sell them.

-There are a lot of value buyers as competitors now.

-Massive derivative books should not be insured by the country.

-Buy stocks as if you were buying the business.

-Own good businesses, but don't pay too much.

-Both Buffett and Munger failed as short sellers.

-Modern acquisition prices are not cheap, but the market can offer some bargains.

-With small amounts of capital look at small caps.

Buffett and Munger are champions of selecting the individual reality about companies and stocks that makes the targeted investment different from others in the same “labeled” group; e.g., food stocks or commercial banks, etc. Their analysis focuses on the differences between what they are looking at and the competition at very current prices. Their bias toward quality helps during declines. They are very conscious of how their present size effectively gets significant impacts from small investments. Like many successful long-term investors they have not been able to prosper through short selling or the use of derivatives outside of hedging. They don’t appear to have long-term targets, but recognize quickly when the stock market gives them an opportunity at an attractive price.

Successful acquisitions

-The key to successful acquisition of clients and companies is getting them onboard through self-selection.

-Most successful businesses are not truly easy to understand or operate.

-Size can be an advantage in down markets.

-Capital allocation is critical to big successes.

-It is easier to buy stocks and companies than to sell them.

-Building by book value is cheaper and may be sounder than acquisitions.

-If you want to be good partners, treat subsidiaries as if the parent was a sub and the acquired was the subsidiary.

-Invest with an idea of what something will look like in 5-10 years.

Since Berkshire’s long-term progress over the last several years of a relatively flat stock market is from significant earnings advances of companies that it owns outright or are a majority holder, it needs to focus on what makes a good acquisition for the company. Personally, I have been both an acquirer and a seller of companies as well as a consultant to parties in these kinds of trades. I recognize that Berkshire, in general has not only made good acquisitions, but much more importantly it has managed with a light touch the purchases of good operations and kept them producing and growing. Berkshire’s capital gathering and allocation skills are among the best acquirers. Most others could learn from them.
 
Analysis

-Focus on operating earnings, not accounting-published earnings.

-As a yardstick to measure Berkshire and other companies, intrinsic value is better, but a more difficult measure to determine than the published accounting book value.

-Imperfect accounting in mergers/acquisitions and changing accounting/data systems can leave holes.

-Math does not disclose competitive advantage.

-Buy businesses not just stocks.

Berkshire Hathaway is very conscious of what accounting statements do not reveal, particularly competitive advantages. Also it is aware that under corporate tax accounting, various assets of “S” corporation and LLC books could look quite different under “C” corporation tax returns. Further, Berkshire knows where to look for potential problems with the assembly of numbers from recent merger activities or the installation of new accounting and tax systems. Berkshire possesses a level of rapid expertise in examining potential acquisitions that most other potential buyers do not bring to the party. These skills are worth a great deal that is not recognized in Berkshire’s book value, but should be acknowledged in an analyst's estimate of intrinsic value.

I would happy to discuss any of these thoughts individually.

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com .

______________________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com .

Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,

All Rights Reserved.

Contact author for limited redistribution permission.