Thursday, November 26, 2009

Venture Capital

This BusinessWeek article on venture capital describes why the process of capital formation and nurturing of new ideas is not working as well as it should or it has in the past. Historically, venture capital in the United States has helped us to be very good at the creative part of the creative-destruction process.

It's my view that all the energy that is put into things like proprietary trading and other related non-productive financial activities is damaging to the US. It saps energy and talent away from the higher calling of matching dollars with good ideas to support innovation and entrepreneurship.

Well venture capital is definitely not one of those non-productive financial activities. We need more of it done well and a whole lot less pure speculation and gambling.

Unfortunately, according to the article, venture capital is not working all that well these days.

Some excerpts from the article:

"In the era of the financialization of everything, corporate and public pension funds got in the game."

"Since institutional investors are under pressure to show short-term returns, VC funds are trying to keep them as investors by going for maximum liquidity, creating early payoffs via premature 'exits' (selling some startups in their portfolios within three years, say). Instead of working to make their best startups strong and independent, they're 'flipping' them..."

"In other words, today the traditional VC fee structure promotes haste in putting money to work rather than skill in developing new enterprises..."

The article closed by saying...

"History attests to the importance of capital sources willing to fund unknown companies exploring uncertain innovations. The sooner we revitalize the stale relationship between VC funds and their investors, the sooner the industry can again support America's entrepreneurs."

So venture capital isn't working very well and Wall Street's brightest expend all kinds of energy on things like prop trading instead of using that same energy in more useful ways. In his most recent letter, Jeremy Grantham noted the following:

"As we ponder the problem of prop trading, let us consider Goldman's stunning $3 billion second quarter profit. It appeared to be almost all hedge fund trading."

Things like less than effective venture capital process and too much emphasis on prop trading is a net loss for the US and, at least, partly explains some of our current problems. It comes down to poor allocation of capital and other resources. When capital is poorly allocated there might be a non-sustainable economic "sugar high" while better ideas goes unfunded or gets underfunded (think of all those "dot-bombs"). Long-term, this reduces wealth and living standards.

More from Grantham's letter:

"...it is worth remembering that every valued job created by financial complexity is paid for by the rest of the real economy, and talent is displaced from real production, as symbolized by all of the nuclear physicists on prop trading desks. Viewed from the perspective of the long-term well-being of the whole economy, the drastic expansion of the U.S. financial system as a percentage of total GDP in the last 20 years has been a drain on the health and cost structure of the balance of the real economy."

Whether it is the current state of venture capital as described in the Businessweek article, prop trading or other related non-productive financial activities, the world would better off if incentives/disincentives were put in place to change the balance. The brainpower being utilized to develop complex trading schemes could certainly be better utilized elsewhere.

Let's just say it's a good thing Brin and Page didn't go to a hedge fund.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, November 24, 2009

Confirmation Bias

Here is an article by Jason Zweig in the Wall Street Journal on the effects of 'confirmation bias' on investing behavior.

An excerpt:

"...your own mind acts like a compulsive yes-man who echoes whatever you want to believe. Psychologists call this mental gremlin the 'confirmation bias.' A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs."

The article goes on to suggest ways to combat the tendency.

Learning to manage it is not an easy thing to do but well worth the trouble.

It starts with a disciplined investment process. An example of a useful rule to put in place is to spend at least as much if not more time reading -- and carefully considering -- opposing views on any investment. This can be a more difficult habit to develop than it sounds. Most of us prefer to read things that reinforce our own thinking.

"The first principle is that you must not fool yourself, and you are the easiest person to fool." - Richard Feynman

In other words, not only do you need to learn to know when to go against the prevailing wisdom of others, it's just as important to know how to challenge your own prevailing wisdom.

This can prove useful -- if implemented the right way -- beyond the world of investing.

Check out the full article.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, November 17, 2009

Berkshire Hathaway 3rd Quarter 2009 13F-HR

In yesterday's Berkshire Hathaway 13F-HR filing some meaningful changes to the $ 61 billion equity portfolio were disclosed:

- Nearly doubled exposure to Wal-Mart
Value of Holding = ~$ 2 billion (9th largest holding)

- Continued to add to Wells Fargo investment
Value of Holding = ~$ 8.8 billion (2nd largest holding in the portfolio after Coca-Cola.)

- Established new position in Exxon Mobil
Value of Holding = ~$ 100 million (Within the context of a $ 61 billion portfolio...pretty small.)

- Established new position in Nestle
Value of Holding = ~$ 161 million (Again...relatively small.)
Buffett now has exposure to every major global confectionary company except Hershey. His investments in this area include: Mars-Wrigley, Kraft-Cadbury (assuming the deal happens), and Nestle. Guess he likes the chocolate and gum biz.

- Established small new position in Republic Services
Value of Holding = ~$ 101 million

- Continued to reduce exposure to ConocoPhillips
Value of Holding = ~$ 3.1 billion (Still the 7th largest holding. Though a position in Exxon was established...ConocoPhillips remains a 30x bigger investment.)

It will be interesting to see how this changes in the coming quarters. So far approximately 1/3 of the shares in ConocoPhillips have been trimmed since the beginning of the year. Buffett announced earlier this year they would be selling a portion of the ConocoPhillips shares at a loss for tax reasons as explained in this news release.

We sold 13.7 million shares of ConocoPhillips during the first quarter and additional shares were sold subsequent to the end of the quarter. Although we expect the market price of ConocoPhillips to increase over time to levels that exceed our original cost, we are likely to sell some additional shares prior to that time and generate additional capital losses that we can carry back to prior tax years when we generated net capital gains. - Berkshire Hathaway News Release

- Reduced exposure to Moody's
Value of Holding = ~$ 900 million (still a medium size position but it appears Buffett is committed to steadily reducing exposure to Moody's.)

There are several other minor changes to the portfolio including: establishing a very small new position in Travelers, completely selling out of small positions in Eaton and Wabco, selling almost all shares of Ingersoll-Rand, and a small reduction in exposure to Suntrust.

Adam

Long positions in Berkshire Hathaway, Wells Fargo, and Moody's.

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Academic Inertia

"Never underestimate the power of a dominant academic idea to choke off competing ideas, and never underestimate the unwillingness of academics to change their views in the face of evidence." - Jeremy Grantham in the 4Q 2008 Quarterly Letter

Monday, November 16, 2009

Kraft and Cadbury

Here is a good article on economic moats.

First, it references a quote from this column in The Economist on the Kraft-Cadbury deal.

Chocolate companies as a breed also have a peculiarly intimate relationship with their customers, partly because chocolate is involved in so many childhood, romantic and festive rituals, and partly because people acquire their tastes in chocolate at their mothers’ knees. Most Britons would rather eat scorpions than Hershey bars. - The Economist

And here are some excerpts from the article itself.

This illustrates how powerful and valuable brands can be. Many parts of the world are currently unfamiliar with chocolate and are "blank slates" in terms of forming brand awareness. As The Economist article points out, the first mover in those countries is likely to build brand loyalty that will be difficult or impossible to displace. Furthermore, since chocolate is a low priced luxury item, the millions of upwardly mobile consumers in developing countries will find it increasingly easy to afford the product.

...Kraft management obviously believes that Cadbury's existing distribution system in places like India will create a powerful economic moat and end up justifying the valuation.

Recently, I posted this on the power of consumer franchises.

...an established consumer franchise with pricing power (and, as a result, superior returns on capital) can use the extra cash coming in to build stronger distribution and buy more advertising. Over time that stronger distribution and bigger ad budget reinforces the strength the of the brand(s) and widens the moat. It's more generic competition with lower margins can't afford to invest as many $'s in product, distribution, and advertising so over time the gap tends to widen. The interplay of these forces makes most of the larger consumer franchises nearly impossible to displace.

As an investment model, looking for businesses with the above characteristics that are selling at reasonable prices is not a bad place to start.

Adam

Long position in KFT

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, November 13, 2009

Buffett & Gates

Here's the transcript from the town hall meeting Warren Buffett and Bill Gates held at Columbia University yesterday. An excerpt:

Response to a question on Burlington Northern
...railroads are tied to the future prosperity of this country. You can't move a railroad to China or India or anyplace else. We start out with the premise, and I can't think of a more sound premise, that there will be more people in this country, 10, 20, 30 years from now. They will be moving more and more goods back and forth to each other. And you have the most environmentally friendly and the most cost-efficient way of doing that on the railroads. The Burlington Northern last year moved -- on average it moved a ton of freight, 470 miles on one gallon of diesel. That is far, far more efficient than what takes place over the highways. You have the situation where overall they use 1/3 less fuel, they put far fewer pollutants into the atmosphere than trucks will. So the rails are in tune with the future. - Warren Buffett

The meeting aired last night on CNBC.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, November 12, 2009

Buffett on Aesop's Formula for Value

Back in February students from business schools were invited to come visit Warren Buffett for a Q&A session.

Here are some excerpts from notes taken during the visit including, among other things, a formula for value that goes back to 600 BC:

Buffett:
When I do invest, I don't care if the stock price goes from $10 to $2 but I do care about if the value went from $10 to $2. Avoid debt. I decided early on that I never wanted to owe more than 25% of my net worth, and I haven't…


Well, at least not since the early days. Buffett prefers to always be in a strong position and too much debt can get in the way of that.

Buffett:
The formula for value was handed down from 600 BC by a guy named Aesop. A bird in the hand is worth two in the bush. Investing is about laying out a bird now to get two or more out of the bush. The keys are to only look at the bushes you like and identify how long it will take to get them out. When interest rates are 20%, you need to get it out right now. When rates are 1%, you have 10 years. Think about what the asset will produce. Look at the asset, not the beta. I don't really care about volatility. Stock price is not that important to me, it just gives you the opportunity to buy at a great price. I don't care if they close the NYSE for 5 years. I care more about the business than I do about events. I care about if there's price flexibility and whether the company can gain more market share. I care about people drinking more Coke.

I bought a farm from the FDIC 20 years ago for $600 per acre. Now I don't know anything about farming but my son does. I asked him, how much it cost to buy corn, plow the field, harvest, how much an acre will yield, what price to expect. I haven't gotten a quote on that farm in 20 years.


Check out the notes in their entirety.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, November 11, 2009

Why Buffett's Not a Big Fan of Gold

Warren Buffett said this about investments in gold during an interview with Becky Quick on CNBC in March:

"I have no views as to where it will be, but the one thing I can tell you is it won't do anything between now and then except look at you. Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot–and it's a lot–it's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that. The idea of digging something up out of the ground, you know, in South Africa or someplace and then transporting it to the United States and putting into the ground, you know, in the Federal Reserve of New York, does not strike me as a terrific asset."

In the long run, a productive asset like a good business (or shares of) is likely to create more value over time than a non-productive asset like a chunk of yellow metal.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything

Tuesday, November 10, 2009

Miscellaneous Munger Quotes

"I don't have too much interest in teaching other people how to get rich. And that isn't because I fear the competition or anything like that — Warren has always been very open about what he's learned, and I share that ethos. My personal behavior model is Lord Keynes: I wanted to get rich so I could be independent, and so I could do other things like give talks on the intersection of psychology and economics. I didn't want to turn it into a total obsession." - Charlie Munger

"We only want what success we can get despite encouraging others to share our general views about reality." - Charlie Munger

"For society, the Internet is wonderful, but for capitalists, it will be a net negative. It will increase efficiency, but lots of things increase efficiency without increasing profits." - Charlie Munger

"When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead—you're destroyed. It happens again and again and again. And when these new businesses come in, there are huge advantages for the early birds. And when you’re an early bird, there's a model that I call 'surfing'—when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows..." - Charlie Munger

"...there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers." - Charlie Munger

Friday, November 6, 2009

The Way of the Dodo

Some excerpts from Grantham's latest letter:

Nobel
"I can't tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee's sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn't seem deserved." - Jeremy Grantham from the 3Q09 Letter

Rational Expectations and Efficient Markets
"Rational expectations and the efficient market hypothesis are as dead as dodos, yet their baleful and painful influence lives on...

...[investment] committee members by and large buy into the idea that portfolio composition should not change and should be fixed as closely as possible to the policy benchmark, which certainly would make sense in that parallel universe where markets really are efficiently priced. This means that you cheerfully own just as much equity in 2000 at 35 times earnings as you did in 1982 at 6 times. This is not a good idea unless you derive enormous personal utility from a display of discipline, perhaps better viewed as inflexibility in this case." - Jeremy Grantham from the 3Q09 Letter


Check out the letter in its entirety.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, November 5, 2009

Warren Buffett on Consumer Franchises: Berkshire Shareholder Letter Highlights

From Buffett's 1983 Berkshire Hathaway (BRKa) shareholder letter:

In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See’s – doing it, furthermore, with conservative accounting and no financial leverage. It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return. Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.

Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price.

The line "pervasive favorable reputation with consumers based upon countless pleasant experiences" is the foundation of an economic moat. The moats of great consumer franchises reside between the ears of their customers. If someone is loyal to a particular beverage because of the taste, for example, they are probably not going to sweat paying 40 cents versus 25 cents (a 60% higher price) for some generic alternative.

On the other hand, if you are some buyer of computer chips for Raytheon, or whatever, you will sweat bullets over a 60% difference in price. This difference in behavior helps explain the reliable premium rates of return for Coca-Cola. The same, give or take, can be said for Wrigley's, Pepsi and other great consumer franchises.

Each are durable wide moat businesses with high returns on capital.

In addition, an established consumer franchise with pricing power (and, as a result, superior returns on capital) can use the extra cash coming in to build stronger distribution and buy more advertising. Over time that stronger distribution and bigger ad budget reinforces the strength the of the brand(s) and widens the moat. It's more generic competition with lower margins can't afford to invest as many $'s in product, distribution, and advertising so over time the gap tends to widen. The interplay of these forces makes most of the larger consumer franchises nearly impossible to displace.

Adam

Long BRKb
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, November 4, 2009

Long-term Competitive Advantage...

"...in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There's no rule that you have to invest money where you've earned it. Indeed, it's often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return." - Warren Buffett in the 2007 Shareholder Letter

Tuesday, November 3, 2009

16 Rules

Good recent post on Walter Schloss.

Excerpt:

In the value investing world, Walter Schloss is a legend. He did not attend college and was initially hired at the age of 18 as a runner on Wall Street in 1934. He took investment courses taught by Graham at the New York Stock Exchange Institute. He eventually went to work for Graham in the Graham-Newman Partnership, at about the same time Warren Buffett worked in the firm.

In 1955, Schloss left Graham's company and started up his own investment firm, eventually managing money for 92 investors. By maintaining a manageable asset size, Schloss averaged a 15.3% compound return over the course of five decades, versus 10% for the S&P 500.
Schloss closed out his fund in 2000 and stopped actively managing others' money in 2003.

Warren Buffett named him as one of The Superinvestors of Graham-and-Doddsville, who disproved the academic position that the market was efficient, and that beating the S&P 500 was "pure chance".

Warren Buffett had this to say about Schloss:

He knows how to identify securities that sell at considerably less than their value to a private owner: And that's all he does. He owns many more stocks than I do and is far less interested in the underlying nature of the business; I don't seem to have very much influence on Walter. That is one of his strengths; no one has much influence on him.
Check out his investing rules.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything

Monday, November 2, 2009

Grantham on Quality Stocks

From Jeremy Grantham's most recent quarterly letter:

Quality stocks (high, stable return and low debt) simply look cheap and have gotten painfully cheaper as the Fed beats investors into buying junk and other risky assets, a hair-of-the-dog strategy if ever there was one. In our seven-year forecast the quality segment has a full seven-percentage-point lead per year over the whole S&P 500, or 9% over the balance ex-quality. This is now at genuine outlier levels.

Grantham later added...

In the long run, quality stocks have proven to be the one free lunch: you simply have not had to pay for the privilege of owning the great safe companies, as plain logic and established theory would both suggest.

For examples of what Grantham specifically means by "quality stocks" check out the top 25 holdings from one of GMO's mutual funds (GMO is Grantham's investment management firm). The fund has an intuitive name: GMO Quality (GQETX).

Adam

Related posts:
Best Performing Mutual Funds - 20 Years
Staples vs Cyclicals
Best and Worst Performing DJIA Stock
Defensive Stocks?
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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