Berkshire Remains Busy

Berkshire Hathaway recently released its second quarter form 13-F, which details the investment conglomerate’s domestic equity holdings as of the end of June 2009. And in this last quarter, Berkshire has continued to be active by selling positions in some holdings, as well as adding a new name to the portfolio.

It should be noted that in last week’s second quarter earnings report, it appears as though Berkshire has been more active in purchasing fixed income securities—primarily international ones—than equities. That said, it is still instructive to monitor Berkshire’s holdings to try and gauge changes in the conglomerate’s thinking. It should also be mentioned that Berkshire does receive exemptions from the SEC to disclose some of its positions, until the conglomerate is able to build a full position in a particular stock.

New Names and Additions

In the last quarter, Berkshire added shares of medical technology company Becton, Dickinson and Company (BDX), which adds yet another healthcare related business to Berkshire’s equity portfolio. And on this front, Berkshire has continued to build back up its position in another healthcare related company, Johnson & Johnson (JNJ), which it was forced to sell some of late last year in order to raise capital for other investments.

In my opinion, each of these moves is noteworthy, as there seems to have been a subtle move towards healthcare and pharmaceutical companies in Berkshire’s portfolio over the last couple years. It is impossible to know for certain Berkshire’s thinking, but if I were to conjecture, I don’t necessarily think it is a favorable top down view of the healthcare sector on Berkshire’s part. Rather, in my view, it could be that many of those businesses have very strong franchises, and have seen their share prices decline as a result of the political uncertainty regarding healthcare reform.

Eliminations and Subtractions

There was only one complete elimination from the portfolio, which was the shares of Constellation Energy (CEG), which Berkshire received as consideration when Constellation pulled out of a deal to be acquired by Berkshire subsidiary Mid-American Energy. Berkshire has been selling its position in Constellation since the beginning of the year, which also had the effect of posting nice gains in Mid-American’s second quarter earnings.

As for the subtractions, Berkshire continued to sell its position in used car retailer Carmax (KMX) during the second quarter. Carmax’s business likely continues to struggle as new car companies liquidate inventories of new cars with the help of both company and government incentives.

Berkshire also continued to sell some of its stake in UnitedHealthcare (UNH), Wellpoint (WLP), Home Depot (HD), Eaton Corp (ETN), and integrated energy company ConocoPhillips (COP). As for Conoco, Berkshire indicated that it sold even more shares since the end of June. These Conoco sales will likely produce realized losses, which Berkshire can use to shield future gains from taxes.

While not showing up as a sale in the second quarter, Berkshire subsequently has also indicated that it has trimmed its position in bond rating firm Moody’s (MCO), which I don’t think is overly surprising given that the reputation of the bond rating firms is effectively on life support right now. That said, Berkshire still owns about 17% of Moody’s.

Unchanged Positions

The bulk of Berkshire’s equity portfolio was unchanged from the prior quarter. Here is a listing of those names:

• American Express (AXP)
• Bank of America (BAC)
• Burlington Northern (BNI)
• Coke (KO)
• Comcast (CMCSA)
• Comdisco (CDCO)
• Costco (COST)
• Gannett (GCI)
• General Electric (GE)
• GlaxoSmithKline (GSK)
• Ingersoll-Rand (IR)
• Iron Mountain (IRM)
• Kraft Foods (KFT)
• Lowes (LOW)
• M&T Bank (MTB)
• Nalco Holdings (NLC)
• Norfolk Southern (NSC)
• NRG Energy (NRG)
• Procter & Gamble (PG)
• Sanofi Aventis (SNY)
• SunTrust Banks (STI)
• Torchmark (TMI)
• US Bancorp (USB)
• United States Gypsum (USG)
• Union Pacific (UNP)
• UPS (UPS)
• Wabco Holdings (WBC)
• Wal-Mart (WMT)
• Washington Post (WPO)
• Wells Fargo (WFC)
• Wesco (WSC)

You might also be interested to know that this blog was mentioned in a Bloomberg article that I have linked here.

This and That

Also, if you haven’t already done so, please be sure to register before time runs out for the first “Late Summer Buffett Conclave” (www.buffettconclave.com), which is a social and networking event on August 28th in Chicago for folks interested in Berkshire. We already have a great group of attendees, and still have space to fit in a few more "Buffettologists." Disclaimer: Neither Mr. Buffett nor Berkshire Hathaway nor any of its employees are affiliated with this event.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

Berkshire Grinds Out 2Q Earnings

Berkshire Hathaway reported second quarter earnings Friday that were largely mixed. While the headline number showed an improvement, that was largely due to gains in some of Berkshire’s derivative contracts, which are non-cash and tend to create more volatility in the conglomerate’s quarterly earnings. Including these derivative positions, though, Berkshire’s second quarter earnings grew 14%.

In the operating businesses, the story was more mixed. The insurance businesses produced satisfactory results, though underwriting profits were mostly down. While auto-insurer GEICO continues to attract new customers seeking cheaper auto-insurance, its underwriting profits were down thanks primarily to higher losses. General Re improved its profits, while Berkshire Hathaway Reinsurance and the primary insurance group saw declines in profitability.

Berkshire did indicate in its quarterly report that it is more willing to take on large exposures than it was earlier in the year, but that it hasn’t yet as industry wide pricing continues to be very competitive. Berkshire’s total insurance float—premiums collected and not yet paid as claims—increased to $61 billion as of June 30. This additional float—as well as preferred stock dividends from GE and Goldman Sachs--helped boost investment income in Berkshire’s insurance operations by a strong 18%.

The utility business earnings also held up okay, despite large revenue declines attributable to both weak demand and lower prices. The results in the utilities did benefit from gains in the stock of Constellation Energy, which Berkshire received as consideration when Constellation pulled out of a deal to be acquired by Berkshire subsidiary Mid-American. If not for these stock gains, Berkshire’s second quarter earnings in its utility businesses would have been down about 7%.

Results in the operating businesses were down more substantially, which wasn’t entirely unexpected, given the revenue and earnings weakness reported by many other similar businesses over the last few weeks. Across the board revenue was down between 20-30% in most of Berkshire’s operating businesses. NetJets revenue was down even more, at 43%, as that business continues to be flat on its back. In addition, NetJets also had a CEO change in just the last week. The one area that held up, and actually showed some modest growth, was McClane (a foodservice provider), which posted an 8% increase in revenue versus the prior year quarter.

Berkshire’s investments recovered somewhat, which helped push the conglomerate’s book value per share up 11.4% during the second quarter. Berkshire’s cash balance now sits at about $21 billion, after its flurry of investment activity over the past year. Berkshire has indicated in the past that it likes to keep at least $10 billion of cash on hand for insurance regulatory purposes, and given the current economic environment, it would seem that Berkshire would want to keep even more cash on hand. As such, if Berkshire were to make an additional investment or acquisition it would probably raise some additional cash to do so by potentially selling some marketable securities, as the conglomerate has already done over the last six months.

You might also be interested to know that this blog was mentioned in an Associated Press article that I have linked here.

This and That

Also, if you haven’t already done so, please be sure to register for the first “Late Summer Buffett Conclave” (www.buffettconclave.com), which is a social and networking event on August 28th in Chicago for folks interested in Berkshire. Disclaimer: Neither Mr. Buffett nor Berkshire Hathaway nor any of its employees are affiliated with this event.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

Management Change at Berkshire Subsidiary NetJets

On Tuesday, it was reported that NetJets’ CEO Richard Santulli was stepping down from his post and would be replaced by David Sokol, former head of Berkshire subsidiary Mid-American, on an interim basis. This announcement was interesting on a couple of fronts, as Santulli had spent 25 years at the company he founded, and to step aside during a difficult time for NetJets was surprising. Secondly, Berkshire hasn’t typically moved executives around to run its different businesses, instead typically promoting from within each business, anytime succession has cropped up at the subsidiary level.

In my opinion, this announcement can be viewed from two different viewpoints. It could indicate that NetJets doesn’t possess the internal candidates that the Berkshire brass believed would be right to lead the organization at this juncture, and as a result, Sokol has stepped in until the right candidate could be identified. If this is indeed the case, it will be interesting to watch how Berkshire handles this, as there will likely be further subsidiary company successions in the coming years, as several of the folks running Berkshire’s other businesses are nearing retirement themselves.

The other way to view this announcement, is that it is yet another vote of confidence by Berkshire in Sokol, who many believe may be one of the leading candidates to eventually replace Chairman Warren Buffett as the operating CEO of Berkshire. Furthermore, this would give Sokol additional experience in running another of Berkshire’s businesses, which would seem to strengthen his qualifications.

Whether Sokol stays on at NetJets for the long haul, or if a different internal or external leader is ultimately identified, this move seems to be a very smooth way to handle succession at NetJets, where the business is likely facing a number of headwinds given the presently weak economic conditions.

You might be interested to know that this blog was mentioned in an Associated Press article, which I have linked here.

This and That

Berkshire is due to report earnings this Friday, so please check back this weekend for my analysis of Berkshire’s second quarter results.

Also, if you haven’t already done so, please be sure to register for the first “Late Summer Buffett Conclave” (www.buffettconclave.com), which is a social and networking event on August 28th in Chicago for folks interested in Berkshire. Disclaimer: Neither Mr. Buffett nor Berkshire Hathaway nor any of its employees are affiliated with this event.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

What is Asset Allocation?

There is an old saying, that if you do the little things right, the big things will take care of themselves. And in almost every case, from a football team driving towards a championship season, to a fledgling business trying to gain customers, does this maxim usually prove correct. Then why, one might ask, in the investment world do most professionals focus most of their time on trying to make the big decisions?

Several years ago, there was a bunch of research done that suggested that most folks’ investment returns were primarily determined by which assets or sectors they allocated a percentage of their capital to. And like the light of a match, people started trying to determine what their “optimal asset allocation framework” should be. They posited that maybe it should be 60% stocks and 40% bonds, or 50% towards healthcare companies and 50% towards commodities, or 20% in cash and 80% in real estate, and well you get the idea, this list goes on. The thinking was, that if you get the exact percentage of each asset class right, it wouldn’t matter so much what the individual investments actually are.

And while I’d probably agree that methodology of this research was likely done with solid empirical backing, I’d argue that the conclusions drawn from it were entirely backward. To me, at least, it seems impossible to determine the exact percentage of one’s portfolio that should be invested in a particular asset class, no matter how much data analysis one does. Nor is it feasible to determine in which asset class, in fact, the money should be invested.

The problem was that most folks’ conclusions were that the most important thing to do was to make big top down decisions about how they wanted to invest their money. I’d argue, on the other hand, that this asset allocation research should instead be interpreted as the outcome of continuously searching for reasonably priced individual investments. And if one starts finding good investments (which can tend to cluster in the same assets or sectors), their portfolio will exhibit a certain “asset allocation framework,” but it will be arrived at by finding good investments, rather than drawing a line in the sand and deciding how the assets should be allocated.

The difference in these interpretations is dramatic. One viewpoint (the top down one) compels action. The other, (the outcome one) educates the investor about what her portfolio actually looks like. And to me, at least, education almost always trumps action.

The bigger implication of this “outcome” viewpoint, though, is that the individual investments do matter. There are thousands of stocks and thousands of bonds, and by just saying that you have 60% of one basket and 40% of another, says nothing about the quality of your portfolio. If, on the other hand, one finds good and understandable investments at reasonable prices, that investor will do just fine, regardless how someone else labels their investments. Just like the old saying above implies, by focusing on the individual investments in your portfolio, your larger “asset allocation framework” will eventually take care of itself.

I welcome dialogue with my readers, so please send me any questions and comments you have. Also, if you haven’t already done so, please be sure to sign-up for my free email alerts by emailing me at BuffettInsights@gmail.com.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

Does Diversification Make Sense?

If you were to go to a restaurant today and order some food, would you order one of everything on the menu, or would you just order a few of the things you really knew that you liked? Chances are—and I might be taking a big leap here—that you would know what you liked for whatever reason (taste, healthiness, price), and would order just a few of those things, rather than thinking you had to have one of everything on the menu. Maybe I’m in the minority here, but that course of action seems to make the most sense to me.

Yet in the investment world, most folks seem to be encouraged to have one of everything off of the proverbial financial menus that larger financial firms offer. The reason typically given for promoting this type of behavior, is that the more investment products one has, the more that person’s portfolio is diversified. This assumes, of course, that diversification is something that should be universally desired among all investors. But does this really make sense?

At first blush, diversification seems like a good idea. In theory, when one investment declines in value, another less correlated investment should tend to rise in value, leaving the investor’s portfolio somewhat unchanged. While this should generally make folks feel better about their portfolios, to me at least, it doesn’t make a lot of sense from an investment perspective. For example, if the aim of a diversified portfolio—a likely moving definition—is to protect investors on the downside, the natural corollary to this, is that investors are giving up the potential for gains as well. And if an unchanged portfolio is the typical outcome of a diversified portfolio, why pay the huge fees of various investment products sold by larger firms? Why not just hold cash?

But I think that in some cases that this “diversification” mantra can be even worse than only holding cash. How many of your portfolios were supposed to be fully diversified over the last year, and even so, they are now worth 40-50% less than they were two years ago? Not much of a ringing endorsement, if you ask me. In times of crisis—just when diversification is needed most—all the correlations of the different investment products tend to converge to one, thereby reducing an investor’s downside protection. In this case, folks would have even been better off holding cash, and what’s more, they wouldn’t have had to pay all those fees to their “financial advisors”—a euphemism for sales person--for their various investment products.

A couple of years ago at the Berkshire Hathaway (BRK-A) annual meeting, an attendee asked Berkshire Vice-Chairman Charlie Munger a question about the merits of diversification in investing, and Munger sagely advised, “The whole secret of investment is to find places where its safe and wise not to diversify.”

If one thinks about this, what Munger is actually saying is that the notion of diversification--as most “financial advisors” interpret it--is nothing but hogwash. Rather, the advice he is imparting in the first part of that statement is that investors should search for a few businesses or securities where the margin of safety is so great—or said another way, the price is so low—that it is highly unlikely for an investor to lose money. Downside protection, in this case, is not contingent on a group esoteric correlations, but rather by the price you pay for a particular investment.

In the “wise” part of the statement, Munger is implying that if you can find a few investments with upside potential, where you understand the business or security so well that you have an edge over others, it would behoove an investor to make that a larger investment in their portfolio, as long as the price paid for the investment has a large enough margin of safety.

And, in my opinion, this approach to investing espoused by Munger is actually better than even diversification in theory, as it gives investors both downside protection as well as the potential for huge upside for their portfolio.

My best wishes to you and yours for a happy and safe Fourth of July holiday.

I welcome dialogue with my readers, so please send me any questions and comments you have. Also, if you haven’t already done so, please be sure to sign-up for my free email alerts by emailing me at BuffettInsights@gmail.com.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

More Box Checking

A lot of you have commented on the last article I wrote, “The Box Checking Syndrome.” Some of you have agreed with me and given me some great examples of box checking in practice, and others of you have vehemently disagreed with my opinion, which I also like, as it gives me different perspectives to think about. But what really gets me excited about all the responses I have received, is that it has indicated to me that this viewpoint has struck a cord with many of you, which means, of course, that this a good debate to have.

And as I have thought more and more about the article, and more importantly all of your responses, it struck me that there are several additional examples of box checking, rather than only the “financial advisors” that I singled out in the first article. The first of these that comes to mind is the accounting industry, which I might add, Berkshire Hathaway (BRK-A) Vice-Chairman Charlie Munger regularly pontificates about each year.

In my opinion, the accounting profession--and for that matter most consultant practices--have made a huge push over the last several years for focusing entirely on a particular firm’s process of doing things—rather than asking why a particular company does things a certain way during an audit.

The reason for this, in my opinion, is not because it is better accounting, bur rather, because it is better for business for these firms to focus on process. If an accounting firm develops what it decides is “best practices” for doing something a particular way, it helps to insulate them from potential lawsuits down the road should something have run afoul during an audit. The defense thus becomes, well if everyone does this particular activity the same way, how can it be wrong? To me, at least, that’s like saying, well if everyone decides to jump off the Golden Gate Bridge, how can that be a bad idea? Doesn’t make a lot of sense now, does it?

The other main reason that I think there is a focus on process, is because it helps the margins of the accounting firms. By developing what they feel is a “best practices” process, they can, in effect, create a simple check-list that their employees can run through during an audit, without ever having to even think about if something makes sense or not. As such, these firms can hire throngs of folks right out of college, which helps to keep their compensation costs down, and effectively pay the people to check boxes off their list, as long as the process is the same. Check, check, check, you’re done, and then onto the next client. Again, any type of thought or rationality has been removed from—ironically—their process, in favor of box checking.

What I find so ironic about all this, is that every four or five years or so, there is some type of fallout or scandal in the markets, and each time most folks try to point their finger at the accounting profession. And rather than examining if the box checking culture could be the culprit, laws are simply passed which require even more “best practices,” processes, and box checking, without ever addressing the real problem. Is it any wonder that accounting shenanigans get repeated over and over again every few years?

The other industry that, in my view, is guilty of the “box checking syndrome” is the credit rating agencies. In my opinion, several of these firms simply developed a bunch of ratios for each particular industry or group of securities, and then associated a group of ratios with a particular credit rating. Then they had their analysts simply crunch a bunch of numbers, and run a bunch of stress tests, and then assign several securities or companies certain ratings, depending on what boxes were--or were not--checked.

Given what has happened in the markets over the last couple years, I think it’s fairly evident what the outcome of all this box checking was. In fact, the reputation of many credit rating firms is now on life support, at best. What makes it even worse, though, is many investors were simply checking boxes of their own, and overly relied on the credit rating firms to help them decide which investments to make. Scary, I know.

Essentially what all this box checking does is try to make shortcuts for things that require a lot of thought, analysis, and judgment. The lesson from all this is not new, as there is simply no substitute for sitting down and rolling up one’s sleeves, doing the analysis, and independently thinking about what makes sense. The bright is, though, that as long as the great majority of people keep going through life checking boxes, for those of us that don’t--and also have the wherewithal to think sensibly--there is huge opportunity.

I welcome dialogue with my readers, so please send me any questions and comments you have. Also, if you haven’t already done so, please be sure to sign-up for my free email alerts email me at buffettinsights@gmail.com.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author

The Box Checking Syndrome

If you, or perhaps you have a child, that has been in almost any school system over the past twenty years, you must be keenly aware that there has been a distinct movement away from written tests to multiple choice examinations, where all a student does is fill in an answer box. Even some students—and probably parents, too—refer to these exams not as multiple choice tests, but as “multiple guess” exams, thereby implying that there is even less thought and analysis given to the exam questions than you might already have believed.

You see, when one is forced to write out an answer to a question, on the other hand, that person is forced to grapple with all sides of a particular issue, form a cogent argument, and put it down on a piece of paper in a way that communicates their point of view to the reader. That, my friends, is a real test (no pun intended) to see if someone actually comprehends a particular concept. It is really quite obvious too. So if it is, why has this been discarded in favor of multiple guess? This reason is also quite obvious, as it is simply easier to check boxes—for both takers and graders—than to write.

And while this box checking syndrome, as I like to call it, perhaps started in schools, it has become much more prevalent elsewhere. You’ll frequent overhear people explaining to friends the reason for their doing something or even going somewhere, was that they wanted to check that box of their list in life (as if there really was some end-all be-all list). Or, when someone applies for a new position, they often spend their application process checking boxes on the Internet about their background, rather than having to write out their reasons why they desire this new role. Or, ever been to a doctor lately? Some doctors simply check off boxes to see if someone’s test scores are all in a “normal” range, and pronounce them healthy, without ever giving effect of whether those boxes or ranges really make sense for the particular person.

While these are but a few of the examples that you might readily observe today, one of the biggest offenders of box checking, in my opinion, is the investment industry. Many financial advisors—a euphemism for sales person to be sure—blindly run through their checklist of questions when they meet with a client, check-off boxes on their list based on the clients response, and then pronounce that the client should have a little bit of everything from the firm (i.e. checking all of the investment product boxes) if they want to be fully diversified. Then they move onto the next prospect and do the same thing. And this is practiced far and wide, despite, in my opinion, being utter nonsense.

This financial advisor box checking, in effect, makes the client feel as though their unique needs are being met--as if unique can be fit into a box--and that the sales person cares more about them than selling product. But what it really is, though, is a systematized approach by many larger firms to simply gather client assets. And then both the advisor and the firm hide behind this diversification—a euphemism for average—mantra, so that the even though the client shouldn’t theoretically lose a lot, they flip side is that they shouldn’t make a lot either. It’s perfect for the advisor, the clients performance will be average at best--without including the enormous downward effect of fees--which means that the client will typically not get angry at any point, and decide to fire them.

But shouldn’t most clients aspire to have better than average performance over the long-term—net of fees? And how many people who were supposed to be fully diversified, have done even worse than those that weren’t diversified over the past year? And if someone has been sold—or I should say checked the boxes—on all the types of investment products a firm has to offer, how is this unique, and how can their “advisor” actually know the intimate details of each product, and more importantly, if it is actually appropriate for the client?

I think each client or prospect should ask their particular “advisor” to write a personal essay—in plain English, no less—which describes what they have learned about a clients personal financial and life circumstances, details why that “advisor” got in the business in the first place, explains to their clients what they actually do all day (probably cold calling), and finally describe the intimate details of each investment product and why it is appropriate for this particular client.

It is then, and only then, that a client or prospect can ascertain whether or not a financial professional actually knows what they are talking about, and has the ability to mentally grapple with the various issues in each person’s unique circumstances. Anything less, and it would probably be very apparent that these “advisors” are just product of what has happened to examinations in most schools. They are simply checking boxes to try and win a clients business.

I welcome dialogue with my readers, so please send me any questions and comments you have. Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from BuffettInsights by emailing me at BuffettInsights@gmail.com.

Justin

Copyright © 2009 BuffettInsights.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author