Tuesday, November 3, 2009

Berkshire Finds Its Elephant

After years of searching for his next elephant, Berkshire Hathaway (BRK-B) Chairman Warren Buffett found it today in railroad company Burlington Northern Santa Fe (BNI). Berkshire had already owned 22% of Burlington, and today announced that it will be acquiring the remainder of the railroad company for a mix of cash and stock that values Burlington at $100 per share, or $34 billion in total.

This deal is significant for a number of reasons. Burlington is the biggest deal that Berkshire has done in a few years, and as such, it will put a lot of the conglomerate’s capital to work at rates better than cash is earning right now. Furthermore, Burlington will continue to diversify Berkshire’s stream of earnings, and add yet another business to its stable of firms with decent competitive strengths.

After decades of under-investment and brutal competition, the railroad industry has improved dramatically over the last several years. Some consolidation has reduced some of the competitive pressures that had afflicted the industry. In addition, railroads have become more efficient, using double-decker rail cars, as well as having the ability to load containers directly from ships onto railcars. And finally, with relatively higher fuel prices, railroads have gained a cost advantage over trucking, potentially making it cheaper to ship via rail.

These improvements were not lost on Buffett or Berkshire Vice-Chairman Charlie Munger, who have commented on these factors at the last couple Berkshire Hathaway Annual Meetings. More than simply observing, though, Berkshire put its money where its mouth was and began amassing stakes in several railroads including Norfolk Southern (NSC), Union-Pacific (UNP), and the aforementioned 22% stake in Burlington. What’s more Berkshire was so interested in Burlington that it even wrote puts on Burlington’s stock in the last couple years.

In my opinion, this deal can be summed up as the purchase of a decent business at a fair price—at trough earnings, perhaps. Furthermore, I think Burlington will benefit from being under the Berkshire umbrella. For example, as Burlington continues to make investments in its business, including upgrading its infrastructure—perhaps with the help of government funding—it will likely be able to make more longer term investments than some of the other publicly traded railroads, that are often subject to more short-term pressures from Wall Street. What’s more, it’s possible that over time Burlington will also benefit from Berkshire’s funding advantage, thereby being able to borrow money at rates cheaper than competitors. Should this eventuate it would give Burlington another leg up on its peers.

There is one other component to this deal that is interesting. In order to promote liquidity for Burlington shareholders, to potentially sell portions of their Berkshire stake should they decide to take stock in the deal, Berkshire announced that it has effected a 1 for 50 stock split on its class-B shares. While stock splits are by definition un-economic events, this split could aid in increasing the liquidity of Berkshire’s stock. If one also considers that Buffett is slowly gifting his stock to the Gates Foundation, and that he has also stipulated that these gifts be sold fairly quickly, the stock split could hasten an even greater trading volume and liquidity in Berkshire’s stock. This could allow Berkshire to eventually be included in the S&P 500 stock index, which would force legions of index funds to buy the stock, potentially creating a huge demand for the shares.

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

As always, I enjoy dialogue with my readers, so please do email my any questions or comments you may have.

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.

Monday, October 26, 2009

Hurricanes? Not this year.

In 2004 four hurricanes struck Florida and the Gulf Coast. In 2005, Hurricane Katrina devastated New Orleans. Insurance losses were high as a result of these storms, and capital levels declined. What’s more, predictions of several years of elevated Hurricane activity were running high—experts called this phenomenon a “multi-decadal oscillation.” This just means that they believe the probability of more hurricanes making landfall was higher. As a result, rates on catastrophe insurance policies in Florida and the Gulf Coast were very high in 2006 and 2007.


Not surprisingly, Berkshire Hathaway (BRK-B) increased its catastrophe business in each of these years, garnering more premiums for less risk. And as luck—or mother nature—would have it, both 2006 and 2007 were quite years for hurricanes, and Berkshire cleaned up, minting profits in its catastrophe reinsurance unit. In 2008, prices began to fall, and as such, Berkshire pulled back on its “cat” writings. However, 2008 was again a relatively quite hurricane season and Berkshire’s insurance units did quite well.

Now, in 2009, with the financial hurricane that hit last year, Berkshire pulled back its capital in some of its traditional “cat” reinsurance businesses, as it had allocated capital more to its investment portfolio where securities prices fell dramatically last year compared to the long-term value of some of them. Even better than only being able to plant these investment seeds this last year, though, 2009 has been an extremely quite year for the traditional type of hurricanes too. As such, despite Berkshire having less “cat” exposure than it has in years past, it will likely see higher profits in its reinsurance businesses when it reports third quarter results.

These additional profits will continue to help build Berkshire’s capital base, potentially making it easier for Chairman Warren Buffett to make either more investments or to have Berkshire’s reinsurance guru, Ajit Jain, possibly increase Berkshire’s insurance exposure if he deems prices to be appropriate.

While I hope this gives you a glimpse into Berkshire’s third quarter earnings due out soon, there is also a lesson to be learned here as well. Buffett has written over and over again that to be both a good investor and great insurance company one has to “be greedy when others are fearful, and fearful when others are greedy.” Here is yet another example of Berkshire doing what it says it will do, treading in waters that others fear, and making handsome profits for shareholders because of it.

You might also be interested to know that I recently made an appearance on Fox Business News, which I have linked here.

I welcome dialogue with my readers so please do send me any questions or comments you may have.

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.

Wednesday, September 23, 2009

Who Is Your Portfolio Manager (or CEO)?

Many college campuses have what is called a “Greek System,” where groups of men and women gather together in organizations called fraternities and sororities. While sometimes (okay, rarely) the aim of these organizations is philanthropic, more often than not it is an entirely social endeavor. While this has the potential to give certain 20 year olds an outlet of sorts (usually negative), or probably more poignantly a group of “instant friends,” it also offers the opportunity to observe how large groups of folks tend to think, and can also be construed as an early-age microcosm of Corporate America.

In most fraternities—or hell, any large organization of people--decisions are typically made by what is deemed to be the most popular or accepted among the majority of members. One or two folks will first throw an idea or two out there, which will tend to be safe ones, as they typically don’t want to offend anyone. This will then serve as the anchor, as almost all other ideas will tend to be a modified version of the first few. The ideas will then be narrowed down and analyzed not on a rationale basis where one examines the potential outcomes (both positive and negative), but rather on who the sponsor of the idea was (popularity contest in a way), or what people believe is the safest and least offensive of the ideas. This, my friends, is what is called “groupthink.”

Maybe in college where some folks seek a sense of belonging above all else, groupthink actually serves its purpose of making people feel like they are bound together in some way. But in almost all other aspects of life, groupthink often produces the safest--and worst--possible outcomes of decisions for almost any organization. If we take most larger investment management—or almost any financial services—organizations as an example, each management, investment, or strategy decision is often made for the benefit of the person making the decision, not the strategy, not the organization, or most importantly, not the client. And if you need proof of this, just observe how many large organizations tend to have both average performance and average clients.

It’s so odd to me that people and organizations, while of course stating that they want to be the best (sounds good, doesn’t it?), are really through their actions trying to be average. Like all things, though, there is a silver lining. For some folks that have the ability to think rationally and independently, they can constantly exploit this drive of large bodies of people to be average, by having the freedom to make rationale, and often unpopular, decisions. And if you need proof of this too, just look again at the investment industry, and ask yourself why so many smaller and independently owned investment management firms have both the performance and clients that continually trounce the performance of the big name brands, where groupthink is so much more prevalent.

But there is another element to this story that also ties right back into college life. The person in most fraternities, and later in life in corporate organizations, that is administering these decisions is the president of the particular organization. And while I readily acknowledge that some presidents have genuine and strong leadership skills (typically from battlefield promotions—no popularity contest there), the majority of presidents are people that are generally likeable, and not offensive in any way. Said another way, they are often not the smartest, not the strongest, not the best leader, but the safest person who relies on groupthink to make decisions.

In college fraternities, they tend to be the person who doesn’t say much, doesn’t have many opinions, has a cherub face with smile, and drinks a lot. Ironically, these are the same people that are often CEO’s or highly compensated portfolio managers at larger organizations. Their skill is not in running an organization or client assets, but just bumping along and not offending anyone, which I might add is the key to getting promoted. And if you need proof of this, just look at how many moronic financial services company CEO’s—and portfolio managers for that matter—were forced out in the last year in the market downturn. They had no idea what was going on or how to lead, they were just the least offensive one living by groupthink and sitting in the chair.

So when you are examining your financial managers, it might behoove you to look for people who have real opinions, and have the emotional temperament and confidence to make unpopular decisions, rather than just the guy that smiles and most everyone seems to constantly pat on the back. He just might be your typical fraternity president.

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

I welcome dialogue with my readers so please do send me any questions or comments you may have.

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.


Wednesday, September 9, 2009

Do You Believe In Magic?

In the Old West certain salesman would travel by covered wagon from territory to territory selling oils, potions, and other elixirs. They hailed their products---which apparently they only had the recipe for—as cure-alls for almost anything that bothered the average frontier settler. It took not long for many folks back then to realize that these “salesman” were, in fact, praying on peoples’ fears and emotions to simply make a buck or two. They were quickly labeled “snake-oil salesmen,” and often run out of town soon after they arrived.

As I think through the last year or two, which included the fire sales of Bear Stearns and Merrill Lynch, the failures of Lehman Brothers and Washington Mutual, and the nationalization of Fannie Mae, Freddie Mac, and AIG, could it be that the financial services industry simply got chalked full of modern day “snake-oil salesmen” who only wanted to make a buck or two off of their clients?

Think about it. Many folks—aspiring first-time homeowners (frontier settlers in a way)—were conditioned to believe that homeownership--at whatever the cost--was one of the only ways that they could fulfill their American Dream. Thus, up from the dust, arose a group of enablers that sold people things that these folks didn’t have a chance of understanding, which didn’t even matter to the purchasers, because their emotions told them they were so close to achieving their dreams. Option-arm’s, pick-a-payment mortgages, and CDO-Squareds, to name a few were all modern day forms of snake oil. The only difference was that unlike the Old West, nobody seemed willing to run these enablers out of town.

Now that the financial system has come back from the proverbial abyss, it would seem that the resultant shakeout should have thrown a lot of these salesman out of the industry, or at least forced others to run them out of town. Perhaps this has occurred in the mortgage industry to some extent, but in other aspects of the financial services industry, these “snake-oil” salesman are as strong as ever.

Let’s take the hedge fund or investment industry as an example. Anyone who takes the time to sit down and read seminal books like Security Analysis and The Intelligent Investor, or even better, the writings of Warren Buffett, should quickly realize that investing is not rocket science. Running the basic numbers, making conservative projections, and valuing and learning about various businesses is not overly difficult, though it does require long hours of reading. What is more difficult about investing, but not impossible, is having the emotional temperament to think and do things independently, and to wait for attractive prices.

While it seems so simple, I rarely hear any investment manager explain what they do in such clear—and understandable—terms. Instead, I hear not all, but many explain that they have a proprietary market model, or that they have spent decades developing a black box that crunches numbers, or that they are currently pursuing a leveraged beta trade (whatever that is), to name a few of the forms of “snake-oil” currently being promoted. What’s more, many further purport that they are the only ones who could have developed these so-called magical tools for creating wealth. Sounds a bit like the Old West now, doesn’t it.

What is even more surprising, though, is that legions of folks seem to blindly buy into this marketing stuff without ever being skeptical. It is as if you can envision a group of folks huddled around the lunch table (covered wagon), eyes glazed over, taking in everything the salesman says as gospel. But to be fair, even if these folks are skeptical, they typically don’t ask poignant questions about what some of these managers really do. Perhaps they are scared to do so, or perhaps they just believe the purported magic of these promoters at face value.

Unfortunately, there is no sure fire way to ferret out what is snake oil or what is legitimate in the investment industry. One thing to think about, though, is that if there is something that you don’t understand after it is explained to you, ask yourself if it sounds like “magic”, and if it does, send the promoter off in his covered wagon in a cloud of dust.

You might also be interested to know that this blog was mentioned in a New York Times article, which I have linked here.

I welcome dialogue with my readers so please do send me any questions or comments you may have.

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.

Monday, August 17, 2009

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.

Saturday, August 8, 2009

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.

Wednesday, August 5, 2009

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.

Monday, July 20, 2009

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.

Friday, July 3, 2009

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.

Thursday, June 18, 2009

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

Tuesday, June 2, 2009

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

Saturday, May 23, 2009

The Opportunity to Begin Anew

Not only do I look forward to May each year for the Berkshire Hathaway (BRK-A) annual meeting, but the month is much more than that too. Yes, it is the beginning of spring, and yes, the tulips are blooming, but more importantly than that, across the country thousands of students are graduating. Maybe it is all the pomp and circumstance, maybe it is all the speeches, maybe it’s the buzz that fills most schools and campuses, but whichever way it grips you, it makes this particular time of year not like any other.

The reason for this, of course, is that even though graduation is the end of an important chapter in many folks’ lives, it also offers the opportunity to start something new. For some it may symbolize an unblemished canvas that they can begin painting in any manner they see fit. Or for others, it may appear to be a road with unending opportunity. And while this privilege of starting anew is typically reserved for graduates each May, whether they be from college, high school, vocational school, or heck, even pre-school, I’d argue that in 2009, many more folks can, in fact, start thinking like graduates again.

You see, what’s happened over the past year in the economy, the investment world, politics, government, and I’d argue pretty much anything else, has caused such an upheaval, and has shell shocked so many people, that almost everyone has now been forced to reset their path to some extent, and probably more poignantly, reexamine their expectations.

And I realize that for many, this hasn’t been a pleasant experience. Businesses have lost customers. As a result, employees have lost jobs. Others have lost savings and retirement. Some have even lost their homes. And the most natural feeling to have when any of these events—or even others that I didn’t mention—occurs is to feel frightened, and to hearken back to the feeling of an easier and more comfortable time. That, in my opinion, is human nature.

What this fails to take account of, though, is that when practically everyone is forced to reset, it also has the effect of creating huge amounts of opportunity for those able to recognize it. Folks who had been unable to make changes, or breakout into something new, because the status quo was so accepted (rightly or wrongly), may now have the opportunity to freely paint their proverbial masterpiece, however they see fit.

For the great majority of people, this means that someone who has lost their job can now think about doing something else that they’ve always wanted to do, but never felt that the timing was right. Or maybe others can retrain themselves to do something that they are more passionate about pursuing. Or even others, can think about starting a business to try and capture some of the customers that existing firms inadvertently jettisoned as they retrenched. All of these are enormous opportunities that often only come around once or twice in a lifetime—if you are lucky.

What got me thinking about all this as an investor were comments made by Berkshire Hathaway Vice-Chairman Charlie Munger in Omaha a few weekends ago. Munger said, and I’m definitely paraphrasing here, that even though the current turmoil is nothing like the 1973-74 retrenchment in the economy and the markets, he knew then that it (73-74) was his time, his only time. He went on to say that unfortunately he had practically no money at that time, which, in fact, is why those times occur. Munger then provided some advice for the audience by saying, “If I were you, I wouldn’t wait for 1973 and 1974. Anytime we get an opportunity to do something that makes sense, we do that.”

And for most folks, be it in their careers, life, or investments, this might, in fact, be their time to do something that in, Munger’s words, “makes sense” for them. As an investor, maybe this means re-examining one’s financial position, and not reacting out of fear, or doing things now that they should have done two years ago to deal with today’s reality, but instead looking at their current opportunity set, and doing something that makes an enormous amount of sense for them right now.

While it seems so simple, what it also requires, in my opinion, is the emotional temperament to confidently think differently. It requires the ability to tune out all the naysayers, or the people trying to sell you product, or those trying to make you afraid of something--which, ironically, is often the same people trying to sell you things--and really start thinking again like a graduate, where the slate is clean and the possibilities are abundant. And even better, this might be the time—the only time—where one can match all these possibilities with their accumulated experience and knowledge, to, in effect, seize their day. After all, Munger’s not such a bad example to follow, as he seized his and became enormously successful.

It is my hope that you—as well as all of today’s graduates--will be too.

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 emailing me at bufffettinsights@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

Monday, May 18, 2009

Berkshire Hathaway Re-allocates Capital

At the Berkshire Hathaway (BRK-A) annual meeting a couple of weeks ago, Chairman Warren Buffett was very enthusiastic about investing in well run banks, and even said, and I paraphrase here, that if there was one stock right now that he would put the bulk of his net worth in, it was Wells Fargo (WFC). And not surprisingly, now with Berkshire releasing its first quarter From-13F, Buffett has evidently been putting his money where his mouth is, as the conglomerate re-allocated some of its equity portfolio, and upped it’s stake in Wells, among others.

Given the continued tumult in markets during the first quarter, which created some potentially bargain prices in businesses that rarely become bargains, it appears as though Berkshire became relatively opportunistic, and added to its holdings in a number of good businesses. To pay for these added stakes, Berkshire sold some of its position in a few other businesses, two of which we have already known that Berkshire was in the process of reducing.

It is also worth noting—and as I had mentioned above—that it appears as though Berkshire has indeed re-allocated some capital among the securities it owns rather than only using new money in its portfolio. This is likely a consequence of Berkshire having a number of other cash commitments, one of which was putting capital into Swiss Re, and then also helping Dow Chemical (Dow) finance its acquisition of Rohm & Haas on April 1. In addition, Buffett’s desire to have gobs of cash on hand for insurance regulatory purposes, and to also take advantage of potentially new investment or acquisition opportunities, is likely behind some of the efforts to re-allocate the portfolio.

Increased Stakes

During the first quarter, Berkshire upped its stake in two banks that it already owned, the aforementioned Wells Fargo as well as US Bancorp (USB), both of which, in my opinion, are high on the quality scale as far as how banks are run. Berkshire also added to its stake in Johnson & Johnson (JNJ), which it had sold some of last fall to help pay for its preferred shares in General Electric (GE) and Goldman Sachs (GS). In fact, Buffett also recently said that he didn’t want to sell part of Berkshire’s J&J position, but that he wanted to have some additional cash on hand at the holding company when he made those two large preferred stock deals. Given that during the first quarter J&J’s share price declined to levels that it hadn’t seen in at least five years, it isn’t surprising, to me at least, that Berkshire bought back in.

Berkshire also continues to accumulate shares in railroads, having continued to up its position in Burlington Northern (BNI) and Union Pacific (UNP). As for the former, Berkshire owns over 20% of the firm, and over the last year has aggressively added to its position, and also wrote some put options on it, which was effectively going long the businesses. On the latter, Berkshire owns a little bit more than 2% of the business based on this most recent filing. As I’ve written about previously, it appears as though the competitive positioning of railroads vis-à-vis truckers has slowly improved, after decades of brutal competition. What is more, it appears, in my opinion, that railroads have also become somewhat more efficient with double-decker trains and being able to load containers from ships right onto rail cars. This may, or may not, have factored into Berkshire’s decision, but with the decline in economic activity over the past years, the price for railroads—and most other transportation or shipping stocks--has also declined, which may have continued to make the price for the railroads somewhat attractive to a long-term buyer like Berkshire.

Finally, Berkshire increased its stake in Nalco Holdings (NLC), which is a business that Berkshire had established a position in last quarter. Nalco is a business that provides water treatment services to its customers.

Here is a summary of the businesses that Berkshire increased its position in last quarter:

• Wells Fargo
• US Bancorp
• Burlington Northern
• Union Pacific
• Nalco Holdings

Decreased Stakes

During the first quarter Berkshire continued to reduce its position in Constellation Energy (CEG). This was not unexpected, as Berkshire’s Mid-American subsidiary attempted to purchase all of Constellation last fall, when the Baltimore utility ran into problems in its energy-trading book, and was in desperate need of a cash infusion to meet collateral calls. Ultimately Mid-American lost out on purchasing Constellation to a deal from a French utility, but as a break-up fee, Berkshire received both cash and shares in Constellation as consideration. Since then, Berkshire has been continuously selling its stake in the utility.

In Berkshire’s most recent annual report, it also indicated that it had been selling some of its position in ConocoPhillips (COP), as the purchase price of some of the lots was so high from last year, that those lots were deemed to be permanently impaired by accounting tests. As such, Berkshire sold some of its stake in Conoco, which also created substantial tax losses, which should help to shield some of Berkshire’s future gains from taxes.

The two decreases that were not disclosed until the filing of this most recent Form 13-F were Berkshire’s position in used car retailer Carmax (KMX), as well as its stake in managed care company, UnitedHealth Group (UNH). In my opinion, Carmax is a business that recently has struggled with declining inventory values of used cars as well as the effective closing of some securitization markets. That said, Carmax could also benefit from the recent large automaker dealer closings, which longer-term, could allow Carmax gain share in the used car market. As of the first quarter filing, Berkshire still had a substantial stake in Carmax, but this is the second quarter in a row where Berkshire has trimmed its position in the business.

As for UnitedHealth, the managed care company continues to struggle with declining enrollments thanks to higher unemployment, and will likely continues to be caught in the cross-hairs, as the government seeks to restructure the health care industry. Similar to Carmax, this is the second quarter in a row that Berkshire has reduced its position in UnitedHealth.

Here is a summary of the businesses that Berkshire decreased its position in last quarter:

• Constellation Energy
• ConocoPhillips
• Carmax
• UnitedHealth Group

Unchanged Positions

Despite the activity above, the bulk of Berkshire’s equity portfolio was unchanged from last quarter, and I’ve listed below those positions that Berkshire continues to own based on its most recent Form 13-F.

• American Express (AXP)
• Bank of America (BAC)
• Coca-Cola (KO)
• Comcast (CMCSA)
• Comdisco (CDCO)
• Costco (COST)
• Eaton (ETN)
• Gannett (GCI)
• General Electric (GE)
• GlaxoSmithKline (GSK)
• Home Depot (HD)
• Ingersoll-Rand (IR)
• Iron Mountain (IRM)
• Kraft (KFT)
• Lowes (LOW)
• M&T Bank (MTB)
• Moodys (MCO)
• Nike (NKE)
• Norfolk Southern (NSC)
• NRG Energy (NRG)
• Procter & Gamble (PG)
• Sanofi-Aventis (SNY)
• SunTrust Bank (STI)
• Torchmark (TMK)
• United States Gypsum (USG)
• UPS (UPS)
• Wabco Holdings (WBC)
• Wal-Mart (WMT)
• Washington Post (WPO)
• Wellpoint (WLP)
• Wesco Financial (WSC)

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.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.

Monday, May 11, 2009

Berkshire Hathaway First Quarter Earnings

On Friday, Berkshire Hathaway (BRK-A) reported first quarter earnings, which, not unexpectedly, were somewhat weak, given the current global economic downturn. In aggregate, Berkshire posted its first quarterly loss since 2001, and while I think the near term could remain challenging for many of the company’s businesses, longer-term Berkshire should emerge even stronger, given the current opportunities for Chairman Warren Buffett to put more capital to work, as well as the potential for some of the conglomerate’s businesses to gain market share.

Overall, Berkshire posted a net loss of almost $1.5 billion in the first quarter. This was primarily driven by write-downs on the conglomerate’s equity holdings of Conoco Philips (COP), as well as declines in some of its derivative positions. The latter are, for the most part, accounting, and not cash, losses, though Berkshire has begun to pay out losses approximating $675 million during the first quarter on some of its high yield credit default swaps (CDS). Since the end of the quarter, Berkshire paid another $450 million of losses on these contracts. As for Conoco, while the writedown is never a good thing, the losses should also allow Berkshire to shield some of its potential future gains from taxes.

Most of Berkshire’s operating business had fairly steep revenue declines during the quarter, and profits fell even more. This isn’t surprising given that many of these businesses are tied to the consumer. The declines were broad based for the most part, though McLane’s revenues held-up, and were relatively flat on the quarter. NetJets probably had the sharpest decline, posting a net loss of $96 million on the quarter, thanks, in part, to $55 million of writedowns of aircraft.

Despite these challenges, not all of Berkshire’s businesses were weak. The insurance businesses produced fairly good results, primarily led by auto-insurer Geico. As consumers have retrenched and examined their expenditures, many have turned to Geico to try and reduce their auto-insurance costs. As such, Geico’s policies-in-force increased at a healthy 10.4% clip on the quarter to 430,000, as the company continues to gain share. In addition, premiums in the Berkshire Hathaway Reinsurance Group increased thanks to a retroactive reinsurance contract with Swiss Re, as well as the continued premium inflows from an already existing pro-rata reinsurance contract with Swiss Re. These contracts have helped push Berkshire’s float—insurance premiums collected but not yet paid as claims—to $60 billion. The utility businesses also produced good results.

On the investing side of the house, and as I’ve written about previously, Berkshire invested 3 billion Swiss Francs in Swiss Re during the quarter, which likely helped to bolster Swiss Re’s ratings during a time of stress for the company. In addition, on April 1, after the first quarter closed, Berkshire invested $3 billion in convertible preferred stock in Dow Chemical (DOW), which helped Dow close its acquisition of Rohm & Haas. Taking account of the Dow deal, Berkshire now has around $20 billion of cash on hand for insurance regulatory purposes and additional investments.

Not surprisingly, Berkshire’s equity holdings, in aggregate, declined during the quarter, given the continued tumult in markets. This, along with the net loss, helped push Berkshire’s book value per share down by approximately 6% during the quarter to about $66,330 per each class-A share.

You might also be interested to know that this newsletter was mentioned in the following Associated Press article, which I have linked here.

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 buffettologist.com by emailing me at buffettinsights@gmail.com.

Copyright 2009 buffettinsights.blogspot.com

Justin

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.

Monday, May 4, 2009

2009’s Woodstock for Capitalists: Recap

I just recently returned from Omaha and the Berkshire Hathaway (BRK-A) Annual Meeting, and as a person that has attended several of these meetings, this one was different on several fronts, in my opinion.

Mood

To begin, the mood of shareholders at the meeting was a bit more somber given what has occurred in the markets and world over the last year. To be sure, some folks have been shell-shocked from what has happened, and they were likely looking to Chairman Warren Buffett, and his partner, Charlie Munger for guidance on how to navigate today’s choppy waters. And by and large Buffett and Munger were very optimistic on the long-term future of the US economy and the opportunity of our economic system to create an even better economic future. What’s more, Buffett also seemed to indicate that there are huge opportunities in the world today, and he hopes to take advantage of a few of them for Berkshire. That said, they also said to not to expect any quick recoveries, and this is significant given the wide ranging number of businesses that Berkshire owns, and as such, the amount of “economic data” Buffett sees from Berkshire’s subsidiaries.

New Q&A Structure


Second, this year’s meeting featured a new question and answer session, where shareholders emailed questions ahead of time to a trio of journalists who selected questions for Buffett and Munger. This was alternated with the usual questions at the microphone from members of the audience. Overwhelmingly, the questions were much better and more germane to Berkshire than they have been in years past. For example, Buffett received several poignant questions about Berkshire’s holdings of Washington Post (WPO), Moodys (MCO), Wells Fargo (WFC), and some of its other private businesses.

Comments on Holdings

On Post, Buffett said that despite the newspaper business essentially dying, Berkshire intends to hold its Post stake. He was somewhat positive on Post’s cable TV and educational (Kaplan) business, but didn’t seem to think this would offset the decline of the newspaper business. As for Moodys, he said they had also drank the kool aid of ever rising home prices, which, in my opinion, has dramatically hurt the credibility of their business. Buffett did say, however, that he thinks it still is a good business, despite both he and Munger’s comments, indicated that neither use ratings when evaluating securities. With Wells Fargo, both Buffett and Munger defended Wells’ businesses model and said it was one of the strongest banks in the industry. This is significant, because it is one of Berkshire’s largest holdings, and through their comments Buffett and Munger were essentially defending their position in the stock, especially considering the government’s “bank stress tests” are due out sometime soon. It is noteworthy, though, that they remained somewhat silent about another large holding, American Express (AXP).

As for Berkshire’s private businesses, Buffett spoke in depth about auto-insurer Geico, and his belief that as a low-cost leader in the industry, Geico has several advantages, and that he expects it to grow even more. In fact, Geico has been one of the few of Berkshire’s subsidiaries that has been growing, as consumers seek to reduce their auto insurance costs. He also spoke favorably about Berkshire’s utility businesses, and indicated that he expects Berkshire to do more in this field. The majority of Berkshire’s other businesses, though are experiencing significant weaknesses in the current economic state, which isn’t surprising given that many are tied directly to the consumer. On balance, I’d postulate that some of the questions, were, in fact, better than the answers that were given, which is a marked contrast from prior years, and what I think is an endorsement of the current Q&A model, as it has appeared to more deeply engage Berkshire’s shareholders.

Expectations For Berkshire


For Berkshire, both Buffett and Munger said that the days of 20% growth in the firm are long gone, primarily due to Berkshire’s massive size. They now target growth for the firm of a few percentage points better than the S&P, on average, each year. Buffett also indicated that Berkshire’s most enduring competitive advantages are its culture, business model, and shareholder base. This is very important, as culture is one of the most important characteristics of any business, yet the hardest to value and quantify. Buffett also indicated that his succession plan for an eventual CEO and one, or more, CIO’s hasn’t changed. They didn’t explicitly address succession at the subsidiary level during the meeting.

Market Commentary

Buffett said that the 1974 period was the best for buying stocks. He said that valuations weren’t as cheap then, but interest rates were also much higher then. He also said that the country was in much better shape then, than it is now. Munger further commented that if stocks decline by 40% on average, they are closer to an attractive price than they have been before.

Both Munger and Buffett also warned that targeting inflation can be a slippery slope and that dollars will most likely purchase less in 10 years than they purchase today. What is more, Buffett also rightly pointed out that it is China—and not the US taxpayer—that is essentially funding the bulk of the current government debt, and Munger was very complimentary of what China has done economically, and also advocated that the US and China should be very friendly because they are joined at the hip.

Earnings

In the afternoon, Buffett gave a brief preview of Berkshire’s first quarter earnings, and indicated that book value was down around 6%. He indicated that Geico and the utilities businesses have done well, while most others have seen weakness in their businesses. Check back at the end of this week, for my analysis of Berkshire’s first quarter earnings, which are due to be released on Friday.

You might also be interested to know that this newsletter was mentioned in the following Associated Press article, which I have linked here, a Marketwatch article, which I have linked here, and a Bloomberg video, which I have linked here.

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 buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.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.

Saturday, May 2, 2009

Greetings from Omaha!

Good morning from Omaha. Shareholders are just filling into the Qwest Center, and this year appears to be again setting record attendance at the meeting. Despite what has been a tough year for Berkshire—and most everyone else for that matter--I’m looking forward to a great day of questions for Chairman Warren Buffett and Vice-Chairman Charlie Munger. Be sure to check back this evening for my analysis and thoughts on 2009’s “Woodstock for Capitalists.”

Justin


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.

Tuesday, April 28, 2009

Berkshire Hathaway Annual Meeting: Preview

In now less than a fortnight, throngs of investors will descend on Omaha for the Berkshire Hathaway (BRK-A) Annual Meeting. In my opinion, this meeting has the potential to be incredibly insightful, given what has occurred in the world and markets over the last year. At this forum, Chairman Warren Buffett and his partner Charlie Munger routinely offer their views on the markets, investing, and life--and boy, do they have a lot to comment on this year.

And at this year’s meeting, in particular, we should be greeted with several good questions for Buffett and Munger, given Berkshire’s decision to have shareholders submit questions to a few journalists ahead of time, which will allow these reporters to select questions that are germane to the audience. This is critical, because in the past, several groups have used the forum to push their own agendas, which were often very political in nature. This was unfortunate, because it reduced the learning opportunity that the meeting presents for the majority of attendees. This year, though, should be different, and here’s what I’ll be listening for, and hoping to learn.

To begin, this is the best forum to learn more about Berkshire. I’ll be curious to hear how the businesses Berkshire owns, in aggregate, are performing, given the weakness in the economy, and their exposure to the consumer sector. In addition, it has been a tumultuous time for most in the insurance industry, and it will be interesting to learn about the opportunities for Berkshire, given that its financial strength--while impacted--is still, in my opinion, one of the strongest in the industry. In fact, I would argue that insurance is also Berkshire’s most important business, as it provides Buffett with float—insurance premiums collected but not paid out as claims—to invest in other businesses.

And on the investing front—which is frankly what most shareholders go to hear about—it will be interesting to see where Berkshire has been putting its money. Last year, we heard about mortgages and auction rate securities, and given the continuous dislocations in markets, it is likely Berkshire has continued to be active.

I am also curious to hear about Berkshire’s prospects for additional acquisitions. In the annual letter, Berkshire indicated it is interested in doing more in the utilities space, which isn’t surprising given that utility acquisitions have the potential to soak up a ton of capital, and offer a regulated, fixed-income like, return. More than that, though, given the problems several private equity firms are having these days, its likely that an all-cash buyer like Berkshire can have its pick of the litter, now that company valuations are much lower than they have been in prior years. Each of these opportunities is vitally important, as it has the potential to move the needle on Berkshire’s long-term valuation.

I also expect several shareholders to ask about succession. While I think that succession at the holding company has been addressed, the bigger question in my mind, at least, is about succession at the subsidiary level. Buffett has said in the past that he has Berkshire’s managers submit to him the name of one individual who would take over each of the businesses each year, and that sometimes he agrees with this choice, while other times he disagrees. While I think this approach is prudent, subsidiary-level succession has the potential to be a bigger issue going forward, given that many of the entrepreneurs that sold businesses to Berkshire are, in fact, getting up in age themselves. As such, I’d like to hear a little more about this aspect of succession planning.

Shareholders will also probably have several questions about Berkshire’s derivative positions, because--as I have alluded to previously--these positions do add some shades of gray to Berkshire’s balance sheet. As such, I think that Berkshire will eventually disclose as much about these positions as it can, all without compromising these contracts profit potential. To be sure, this is a delicate balance.

My favorite aspects of the meeting, though, are when Buffett and Munger are asked very general questions about investing and life. Their insights, in my mind, are simple and timeless, and provide of sense of grounding to the attendees. Munger has said in past years that folks come out of Omaha each year to “get religion”, and this year they may be more in need of it, than in year’s past.

Given both Buffett and Munger’s vast experience and voracity for reading, I will be particularly interested to see what parallels in the annals of history and capitalism they use to illuminate what happened in today’s world and markets. It’s usually the comments about the softer aspects, such as peoples psychology or behavior, that is so enlightening, and hopefully there will be a couple of nuggets in this year’s meeting too.

As always, I will also be making the pilgrimage out to Omaha for the meeting, so be sure to check back at the first weekend of May for my commentary and analysis of 2009’s “Woodstock for Capitalists”.

Justin

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.

Monday, April 13, 2009

Berkshire Downgraded

In the last few weeks, Berkshire Hathaway (BRK-A) has been downgraded from its triple-A rating, with Moody’s being the most recent firm to strip Berkshire of its prized position. While it is never a good thing for a company to lose its triple-A status, I don’t think these moves will have an overly material effect on Berkshire, or the perception of its financial strength in the marketplace.

Over the last year, several companies, such as AIG, and securities, including a bevy of mortgage related investments, that had been rated very highly have been proven out over the past year to have not deserved their previously lofty status. As such, several firms that had bestowed these ratings, now appear to have egg on their face, and as a result, are reviewing their ratings on almost all other companies and securities. In my opinion, this type of review is generally a good idea, and something that should be done constantly, but I also think that current market circumstances are causing some of these firms to now be overly conservative.

And this, in a nutshell, is what I think has happened to Berkshire’s rating. By all appearances, Berkshire still seems—to me, at least—to be a bastion of financial strength. The conglomerate has more than $20 billion of cash on its balance sheet. In addition, it has tens of billions of both equity and fixed income securities that it could sell in the marketplace if it needed to raise capital. Several of its subsidiaries are still sending cash to Omaha for Chairman Warren Buffett to invest, though probably less than last year. And finally, the company has little debt, other than in its utilities and manufactured housing subsidiaries, whose debt does not appear to have recourse to the assets of the holding company.

While I think that all of the elements I just described help to illustrate the soundness of Berkshire’s financial health, there are some things to watch too. Berkshire’s bigger foray into the derivatives market—especially after warning about their risks for years--certainly adds some complexity to the conglomerate’s balance sheet. And even though I think the profit potential of these contracts is good, in an era where simple is now better, Berkshire’s derivative positions do add a couple shades of gray to its financial position. It is important to remember, though, that Berkshire has minimal collateral posting requirements on its derivatives in the event of any sort of downgrade. This is critical, because, if you’ll remember, collateral postings on derivative positions are what led to the downfall of AIG. The other things to watch are not new. Chief among these is succession planning, which has been acknowledged, and, in my opinion, addressed.

It seems that at some point, there will not be any--or maybe just a few--triple-A rated companies left. What that essentially means then, is that double-A will be, in effect, the new triple-A. And if this eventuates, the scale will have just slid down, and Berkshire—even with its recent downgrade—will still have some of the best ratings around.

You might also be interested to know that this article was recently mentioned in a Bloomberg article, which I’ve linked here, as well as an Associated Press article, which I’ve linked here.

Justin


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.