Friday, August 30, 2013

Hedge Fund Performance

From this recent Wall Street Journal article on hedge fund performance:

Chart: Hedge Funds vs Mutual Funds vs S&P 500

- The average hedge fund rose 4% this year through August 9th.

- The S&P 500 had a total return of 20% over the same period of time.

- The average hedge fund also underperformed the markets last year with an 8% gain versus 16% total return for the S&P 500.

- Less than 5% of the hedge funds outperformed the S&P 500 so far this year.

- Roughly 25% of the funds posted absolute losses.

Well, at least they're not actually managing all that much money...

According to the article, these 708 hedge funds are now managing something $1.5 trillion including long and short positions.

$ 1.5 TRILLION

Well, at least the typical fees they charge aren't too unreasonable...

2% of total assets as a management fee plus 20% of profits.

Incredible.

So last month the Securities and Exchange Commission voted to lift an 80-year restrictions on advertising by hedge funds. From this Barron's article:

"...the government, which has been tightening rules for cigarette advertising for decades, apparently has determined that, while the latter may be harmful to your health, it's okay to tout things that have proven deleterious to the wealth of the well-to-do."

The article later asks, with an expensive "product that turned $10 million into $9 million, while the off-the-rack generic grew that into $14 million" to sell, what should an ad agency do?

The article suggests that maybe a focus on prestige instead of performance might work.

"If you invest in hedge funds, it means you're rich enough to afford to lose money. Nothing says wealth like handing your dough to a big-name hedgie and watching it shrivel."

That Barron's article also suggested some possible ads...

'You have your own chef and a personal trainer. You don't fly commercial. You pay way too much for everything. And you don't have a hedge fund?'

'In these days of rising taxes, it's more important than ever to plan. Our hedge fund is a perfect offset to your capital gains.'

'A boat is a hole in the water where you pour money. You already have a yacht. So buy our hedge fund.'

In the article, Barron's offers some other ad possibilities as well.

This Bloomberg Businessweek article makes its case against hedge funds in a slightly less subtle way.

Bloomberg Businessweek: Hedge Funds Are For Suckers

In this Bloomberg article, George Soros said hedge funds can't beat the market because of fees.

Advertising for these investment vehicles are supposed to remain limited to accredited investors. We'll see how that works out. In any case, this might be one of the better examples where being excluded from an exclusive club should generally be considered a happy outcome.

Of course, there's no doubt some very good hedge funds out there.

This chart does show that the "Hedge Fund VIP Basket" did outperform the S&P 500. I suppose that implies to some that being in this even more exclusive club is the way to go.

Yet I suspect picking the winning long-term managers beforehand will continue to be not necessarily all that easy.

It's worth mentioning that such short time frames don't reveal much of anything in terms of relative or absolute performance.

Also, figuring out how much risk is being taken is critical and not always easy to do. Returns are easily quantified. Risks are not (and is certainly not measured by beta).

So much longer time frames are needed to make a sound judgment. That's naturally part of the problem when it comes to picking who can be trusted managing funds. Practically speaking, not enough have the 20-30 years of performance that ideally could be used as a basis for judging performance.

It's also worth noting that -- even if hedge funds did tend to outperform -- all these fees, in aggregate, are simply a siphoning of funds that would otherwise be savings and investment. Jeremy Grantham once made the point that the frictional costs resulting from fees being charged actually "raid the balance sheet" of investors.

I think Grantham gets it just about right.

In any case, at least to me, it all seems a terrible way of getting the important function of capital formation and development done.

Unfortunately, it has evolved in this way. I certainly don't blame anyone who does it for an honest living. They are simply going where the money is.

That doesn't mean it's serving us all that well overall in its current form.

That doesn't mean it isn't costly well beyond the explicit fees.

Considering the interests involved and other forces at work (including very powerful psychological ones), it's unlikely there'll be material changes anytime soon.

It would be different if hedge funds remained a small niche in the capital markets but, well, last time I checked $ 1.5 trillion is real money.

And that's only a subset of the industry. According to this article there are now roughly 10,000 hedge funds. They manage something like $2.3 trillion.

Will that number become significantly higher years down the road?

Will the lifting the advertising restrictions have a big impact?

Time will tell.

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, August 28, 2013

Munger's Daily Journal: Decisive Shift Into Stocks

Daily Journal Corporation (DJCO) has had, to say the very least, substantial success with its investments in recent years.

The company is a publisher based in Los Angeles that has been shifting its excess cash into stocks picked by Charlie Munger and J.P. Guerin.

Charlie Munger is the non-executive chairman of Daily Journal and, of course, the vice chairman of Berkshire Hathaway (BRKa). While better known for serving as Warren Buffett's business partner, he's also been more quietly serving as the chairman and a director at Daily Journal since 1977.

J.P. Guerin is the vice-chairman of Daily Journal.

Well, they've had so much success in recent years that, back in February of 2013, the SEC formally asked why Daily Journal shouldn't be considered an investment company (as defined in the Investment Company Act of 1940).

Here's the Daily Journal's rather lengthy response.

Among other things, the SEC noted the high percentage of Daily Journal's total assets that are now marketable securities. This is important for the following reason as explained in Daily Journal's response: "...the Investment Company Act (the 'Act') defines an investment company as an issuer (i) 'engaged … in the business of investing, reinvesting, owning, holding, or trading in securities' and (ii) whose assets are at least 40% investment securities."

They go on to further explain that "the Act exempts from this definition any issuer 'primarily engaged, directly or through a wholly-owned subsidiary or subsidiaries, in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities.'"

I found this part of their response, where they explain why in their view the above noted exemption applies, of particular interest:

"...Daily Journal is not just 'primarily' engaged in businesses other than investing - it is entirely engaged in other businesses. The Company and its two wholly-owned subsidiaries have nearly 275 employees and contractors, all of whom are engaged either in the publication of newspapers and magazines or the development and licensing of case management software.

There is no question that Daily Journal's marketable securities currently exceed 40% of its total assets. This is due to the wise decision of the Board of Directors in 2009 to begin shifting the Company's cash and cash equivalents into marketable securities that have appreciated significantly. The Board recognized that this decision would be contrary to the conventional (but questionable) notion that the least risky way to preserve corporate capital for the long-term benefit of stockholders is to invest it in government bonds at interest rates approximating zero, notwithstanding rising inflation.

That the Company even had excess cash to invest is due primarily to the confluence of a unique aspect of its publishing business and the country's largest financial crisis in more than 70 years. The Company's newspapers are 'adjudicated', which means they are eligible to publish legal notices, including notices of residential foreclosure sales that are required by California and Arizona law to be published by the foreclosure trustee in an adjudicated newspaper. The Company aggressively competes for the opportunity to publish trustee foreclosure notices, and there were lots and lots of them to be published in California and Arizona beginning in 2006.

So, while the 'Great Recession' ironically benefitted Daily Journal, the Board knew that it needed to plan for the Company's post-recession operations. To do that, the Company needed to (1) hedge a very difficult environment for newspapers generally, (2) provide for an asset base from which to pursue attractive acquisition opportunities, and (3) establish a minimum net worth that would enable it to bid on significant government software contracts that the Company had been too small to qualify for in the past. Accordingly, the Board decided to purchase three securities selected by Charles Munger, the Company's non-executive chairman, and J.P. Guerin, the Company's vice-chairman. Those investments were quite successful, and the Company now holds positions in six securities."

In July of 2013, the SEC said they had completed their review while making it clear future actions could still be taken.

Consider that, at the end of 2004, Daily Journal had net cash and investments (at that time primarily U.S. Treasury Bills) of $ 11.26 million. After subtracting notes payable of $ 4.55 million, net cash and investments was ~ $ 6.71 million.*

As of the most recent quarter -- nearly but not quite 10 years later -- Daily Journal had cash and investments (now, primarily made up of the six stocks) of $ 134.7 million. After subtracting $ 14.0 million in margin borrowing net cash and investments was ~$ 120.7 million.**

So I'd say they've put their capital (including free cash flow over that time) to rather wise use over the past decade or so.

Adam

No position in DJCO; long position in BRKb

* In 2004, Daily Journal earned $ 3.73 million on $ 34.82 million in revenue. While earnings have been quite a bit higher in recent years, the company has earned $ 2.81 million on $ 26.65 million in revenue over the first three quarters of 2013. A similar annualized run rate. Still, seems tough to judge what the future earning power might be. So, as is pointed out above, though Daily Journal was actually impacted favorably by the "Great Recession", earnings appear to be coming back down to earth from temporarily inflated levels. The important lesson is that, instead of, with excess cash, making dumb investments in the core business that might have generated questionable returns, they waited patiently then decisively bought marketable securities they believed to be mispriced and cheap. That should sound familiar to anyone who's been following what Charlie Munger and Warren Buffett have been saying and doing over these many years.
** Investments were primarily in common stocks but also certain bonds were purchased as explained in the Liquidity and Capital Resources section of prior 10-Qs and 10-Ks. Also consider that Daily Journal recently invested $ 14.0 million in cash -- $ 11.878 million net of cash acquired -- to buy all of the outstanding stock of New Dawn Technologies. So cash and investments would otherwise be even greater.
---
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, August 23, 2013

Market Freezes Up

Those watching business news yesterday had to listen to talking heads acting like -- if not the end of the world -- that not being able to trade Nasdaq stocks for a few hours was yet another blow to market participant confidence.

Nasdaq market paralyzed by three hour shutdown

Well that may be the case but a marketable stock is, first and foremost, partial ownership of an operating business.

"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." - Warren Buffett

So, if the market system happens to malfunction from time to time -- as it seems almost certain to do, and maybe to a much greater extent than this most recent episode -- it doesn't change the per share intrinsic value of that underlying operating business. Those with an investment time horizon were fine; traders maybe less so.
(In the flash crash certain stocks temporarily were significantly impacted. That event similarly had no impact on underlying business value. An investor who did nothing, or maybe even bought shares they liked that became a bit cheaper, was just fine.)

Now, as Charlie Munger pointed out in a conversation at Harvard-Westlake back in early 2010, there is a real benefit to knowing one can sell, relatively easily, part or all of an investment that they've made; that those risking capital become more apt to invest if they feel certain they'll generally have, when the appropriate times comes along, a straightforward, low cost, way to sell.

As Munger says: "It's not like buying a restaurant in the wrong place."

That doesn't logically mean one must be able to sell their shares every second, minute, and hour of every trading day. The beneficial aspects of this ease of conversion -- from one investment to another -- exists as long as what should be an advantage isn't turned into a disadvantage by doing lots of unnecessary trading.

Actual investment (as opposed to trading price action) just doesn't require all that much buying and selling.*

Certainly not anywhere near the amount that our hyperactive modern market system allows participants to theoretically do.

In fact, in many ways, capital formation and investment is undoubtedly negatively impacted by this hyperactivity and other forms of short-termism.

Closing a market for five years may be extremely unlikely, but it's true that a few hours should matter little to the true investor.

It's what the business does over an investment horizon that matters.

Nasdaq Flash Freeze Called 'Inexcusable'

Nasdaq OMX connectivity disaster highlights stumbling markets

Words like "inexcusable" and "disaster" may apply in some ways but, if anything, the problem seems more that we have too many market participants focused on frenetically trading in and out of marketable stocks (not to mention their derivatives). Adding layers of activity and related costs with mostly no particular enduring value added (and, as we've seen from the financial crisis, some of it plainly destructive).

It's renting price action -- what is often a zero-sum game before the frictional costs -- instead of owning pieces of businesses then benefiting from what they produce over the long haul.

Profiting from speculation on near-term price action depends upon cleverly timed trades to get good results.

In contrast, the primary drivers of investment returns come from changes to intrinsic value and the discipline to not overpay in the first place.**

An actual investment is definitely not zero sum; it depends not upon brilliant trading.

Considering the power of long run compounding effects, it seems foolish to no allow those forces to work for the investor. What initially seems like a minor tailwind becomes anything but with the benefit of longer time frames. Well, all this frenetic trading and resultant frictional costs can only, in aggregate, subtract from the magic of compounding returns.
(John Bogle calls this "the tyranny of compounding cost".)

There has certainly been lots of scientific and technological advancements that have enabled all this market hyperactivity.

James Grant once said that in science and engineering more generally (i.e. not just as it relates to finance and financial systems), progress tends to be cumulative.

Unfortunately, that's not really the case in finance.

"Progress is cumulative in science and engineering, but cyclical in finance." - James Grant in Money of the Mind

Grant put it the following way in his latest letter:

"Plainly, physics has made a different kind of contribution to human society than economics has. Then, again, physics is an easier nut to crack than economics. Electrons don't have feelings, as they say.

Progress in science is cumulative; we stand on the shoulders of giants. But progress in finance is cyclical; in money and banking, especially, we seem to keep making the same mistakes." - From Page 17-18 in Grant's Interest Rate Observer, Volume 31 Summer Break, August 23rd, 2013

Apparently, when scientific and technological progress meets financial progress, it is the latter's inherent cyclicality that wins.
(Cyclical in the sense that the same, or at least similar, mistakes seem to be repeated but the size of the financial sector as a percentage of U.S. GDP has been anything but cyclical -- especially since the 1940s.)

The systems have certainly become more sophisticated and technically complex. Whether, as a result, it's serving us better in most of the important ways seems debatable at best.

A market freeze up certainly matters for someone who has funds exposed to the market that are needed in the near term. Of course, funds needed in the near or even intermediate term shouldn't really be exposed to equities in the first place.
(Investment is ideally measured in decades, not years, but the appropriate time horizon is necessarily imprecise and unique to each situation. 2-3 years may seem long-term to some folks but, in my book, that kind of time horizon is simply not an investment horizon.)

A market disturbance like the one yesterday no doubt can pose real problems for the active trader. Yet Buffett and Munger explained back in May of this year why these sort of events should be of little concern to the long-term investor.

During such similar disturbances, the long-term investor who bought (via a marketable stock) part of a quality business at a reasonable valuation in the first place isn't hurt (again, even if the quoted price is temporarily an unpleasant one).

In fact, if it ended up being more than a short-term event, the reduced price should also not bother the long-term owner.

Why?

Well, it not only allows that owner to buy more shares cheap over time, it also allows the funds being allocated to share buybacks to go further. The highest quality businesses generally will throw off excess cash at a high return on capital. So a long-term investor focused on per share intrinsic business value should logically prefer lower stock prices in the near-term (and, for that matter, even the intermediate-term...the longer the low price persists the more powerful a buyback becomes when consistently executed below per share intrinsic value) while the business itself remains, at least, relatively sound.

Naturally an investor should want the earning power of a business to do well over the long haul but, as Warren Buffett has previously explained, a stock price that temporarily (or longer) lags is hardly a problem for the long-term investor.

Investment is about what the business itself produces over time.

Why Buffett Wants IBM's Shares "To Languish"

The intrinsic value of a productive asset (in this case a business that happens to be partially owned via a publicly traded marketable stock), especially one with durable advantages, just will not generally change nearly as much in underlying value as the daily quoted prices might otherwise suggest. There's inevitably lots of noise and, well, emotion in the short-term "votes" of a publicly traded company. A private business owner has no such noise and emotion to consider. With no daily quoted prices to distract, a long-term oriented private business owner can theoretically just focus on making sure the business is being run in a way that creates enduring value.
(Still, even with this longer term focus many businesses will do poorly or fail, of course.)

It need be no different for owners of a high quality business that happens to be publicly traded.

So these almost-certain-to-occur-from-time-to-time market disturbances matter a whole bunch for traders but not so much for investors. When justifiably confident in per share value, the investor focused on long-term effects is not going to mind if something bought at a discount temporarily gets an even bigger discount.

Highly volatile, unpredictable markets (whether due to self-inflicted instability/uncertainty -- market structure, poor system design -- or an external shock) can impact the real economy if severe enough to damage business and consumer confidence.

This can also keep investors who otherwise might participate in the capital markets from doing so.

That's quite a different but potentially very real problem.

Yesterday seemed pretty mild, but I don't doubt that the more serious versions of these kind of events adversely impacts confidence. Yet a more deeply embedded -- culturally and systemically -- longer term perspective among a greater proportion of participants just might mitigate this. Some education -- the development of an alternative trained response to market fluctuations -- and the right incentives can take us a long way toward material improvement in this regard.

So both a cultural shift and systemic changes will certainly be necessary. Well, I think it's fair to say that this kind of fundamental shift is unlikely to happen fast even in the best of circumstances.

In any case, for those with a longer investment horizon, the markets should be made as welcoming as possible.

For pure near-term speculation on price action, markets should be made a less welcoming place.

That'd make for a better balance than what's currently in place.

In the meantime, a long-term investor can still do just fine if they follow sound investment principles.

Buy only what is well understood.***

Focus on underlying business value.

Always have a margin of safety.

Ignore the near-term noise.

In fact, even better yet, is allowing the inevitable market fluctuations resulting from disturbances both small -- as in what happened yesterday -- and large -- as in the financial crisis -- to work for the investor.

The right temperament goes a long way in investing.

Adam

* Charlie Munger also points out -- using Alan Greenspan as an example but there are many others, of course -- some economists are in a camp that thinks "if you had a really free, liquid, wonderful market in securities, that would be wonderful, and the bigger and more wonderful it was, the better it was for the wider civilization." He also adds that some "presumably are looking forward to trillions" of shares being traded and then says:

"Our civilization is not going to work better if we have trillions of shares traded everyday. It's the most asinine idea you could ever have to extrapolate so vigorously..."

Munger states that Alan Greenspan's view of the world when he was leading the Federal Reserve was the the result of having "overdosed on Ayn Rand." Greenspan's views may have changed since (or, maybe, directly as a result of) the financial crisis but were a real factor at the time. At the very least he has seemingly been willing to modify his world view in light of what happened. Others appear less inclined to do so.
** It's buying shares of well understood businesses, with a margin of safety, and for the most part judging correctly -- within a range -- the core long-term economics. False precision in investing just leads to trouble. Act accordingly. It's recognizing what can't be reliably known or predicted. Margin of safety can be seen as just the humble acceptance of one's own limits; the understanding that an inevitably uncertain world exists. Overconfidence in one's own ability to forecast future outcomes will likely lead to more risks taken for less reward over the long haul. When an investor always strives to pay a price that requires nothing great to happen to get a good result, there should be few complaints if things go better than expected. This requires patience, discipline, and often a fair amount of work, but eventually the market usually offers an attractive price of something that is well understood. When it does decisive action is required. Easier said than done if not impossible. When an investor protects against permanent capital loss by employing sufficient margin of safety, the good news is it then also allows unforeseen (or unforeseeable) upside to remain a possibility.
*** Naturally, whether an investment can be understood well is necessarily unique to each investor. Those who make a particular investment because someone else thinks it has attractive long-term prospects (i.e. without having come to that conclusion via their own analysis) just aren't likely to have the conviction needed to hang in there -- or, well, to not hang in there if a mistake was made -- when the price action goes the wrong way. Stick with what you know.
---
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, August 21, 2013

Munger: "Cognitive Failure" In Economics

From this conversation with Charlie Munger at Harvard-Westlake:

"Alan Greenspan at the Federal Reserve overdosed on Ayn Rand. Basically he kind of thought anything that happened in the free market, even if it was an axe murder, had to be ok. He's a smart man and [a] good man, but he got it wrong. Generally, an over-belief in any one ideology is going to do you in if you extrapolate it too hard, and that's what happened in economics."

So, according to Munger, what caused this "cognitive failure" in economics?

"They reasoned correctly that a free market would be way more predictive than anything else, and they reasoned correctly that once you had a fairly advanced capitalist system – if the people that were putting up the capital could sell their pieces of ownership in the company to other people, they'd be more inclined to invest because it gave them an option to get out if they wanted to leave. It's not like buying a restaurant in the wrong place. Then they reasoned that if that was true, if you had a really free, liquid, wonderful market in securities, that would be wonderful, and the bigger and more wonderful it was, the better it was for the wider civilization."

Having a million shares trade in a day was a rare occurrence when Munger attended Harvard Law School. Now billions of shares trade each day. He guesses that those who think along these lines are probably looking forward to when trillions of shares will trade in a day. Munger then adds...

"Our civilization is not going to work better if we have trillions of shares traded everyday. It's the most asinine idea you could ever have to extrapolate so vigorously, and of course three or four billion shares is way too many. We have computer programs that are trading with other computer programs. We have many of the bright people who ought to be doing our engineering going to work at hedge funds and investment banks and algorithmic trading places and so on and so on."

Munger goes on to say "at any rate, these people got the idea [that] unlimited trading is a big plus for civilization."

Well, John Maynard Keynes certainly thought otherwise as Munger further explains:

"[Keynes] said a liquid market of securities is one of the most attractive gambling devices ever created. It has all the joy of gambling, plus it's respectable. Furthermore, instead of being a zero-sum game, where you are bound to lose the frictional cost, it's a game where you can pay the frictional cost and actually make a profit. This is one of the most seductive gambling devices ever invented by man, and some nut who took economics thinks that the bigger and better it gets, the better it is for wider civilization."

Now, consider that speaking to Forbes back in 1974, Warren Buffett described the business of investing in the following manner:

"I call investing the greatest business in the world...because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."

Investing can certainly be a great business but all this hyperactivity is directly at odds with the reasons why.

Compared to all this rapid trading of price action, waiting patiently for something you understand to get cheap enough, then owning it for a very long time, is a completely different game.

Modern capital markets are an incredibly convenient way to buy part of a good business that's priced attractively with minimal frictional costs.

To me, it seems quite the shame to see something so incredibly useful and powerful converted into a casino; see it turned into something less than it otherwise might be.*

So more of something doesn't automatically make it better. There's often optimal amount -- at least within some range -- and, of course, diminishing returns or worse. Some short-term oriented speculative activity is necessary and even desirable. That doesn't logically mean that unlimited amounts of it is a good thing. 

The amount of speculation relative to investment matters and the former is currently swamping the latter. What John Bogle describes as The Triumph of Speculation over Investment.

There may not be a precisely knowable correct ratio of speculation to investment, but I think it's safe to say we are far from what makes sense. I've used the petrol engine as a simple -- even if a limited and imperfect one -- example of this. 

The petrol engine just doesn't function all that well if the air-fuel ratio strays too far from what's optimal (and, eventually, it won't function at all if there's too much of either substance).

As with most any system, even what is a comparably simple one, the proportion matters rather a lot.

If efficiently and effectively allocating capital and strong long-term business performance are the primary goals then, in their current hyperactive form, the equity markets seem likely to have far from the optimal ratio of speculation relative to investment.

Check out the entire 
conversation with Charlie Munger at Harvard-Westlake. 

Lots of useful thoughts and insights.

That 1974 Forbes article is a pretty worthwhile read too even if not exactly breaking news.

Adam

* Capital markets exist to move funds to where they're needed efficiently, to make sure owners of public companies have some reasonable visibility into how well what they own is being managed for the long haul so they can act accordingly, with frictional costs no higher than necessary. It's not a casino that exists to mostly serve the active participants themselves.

Charlie Munger at Harvard-Westlake

Thursday, August 15, 2013

Berkshire Hathaway 2nd Quarter 2013 13F-HR

The Berkshire Hathaway (BRKa) 2nd Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 1st Quarter 13F-HR.)

There was plenty of buying and selling during the quarter. Here's a quick summary of the changes:*

New Positions
Suncor (SU): Bought 17.8 million shares worth $ 581.4 million
Dish (DISH): 547 thousand shares worth $ 24.5 million

Added to Existing Positions
Wells Fargo (WFC): Bought 4.96 million shares worth $ 213.8 million, total stake now $ 20.0 billion
U.S. Bancorp (USB): 16.8 million shares worth $ 621.8 million, total stake $ 2.9 billion
General Motors (GM): 15.0 million shares worth $ 533.6 million, total stake $ 1.4 billion
BNY Mellon (BK): 5.7 million shares worth $ 175.1 million, total stake $ 756.3 million
National Oilwell Varco (NOV): 1.4 million shares worth $ 102.4 million, total stake $ 651.8 million
Chicago Bridge & Iron (CBI): 3.0 million shares worth $ 183.7 million, total stake $ 576.9 million
Verisign (VRSN): 2.7 million shares worth $ 134.1 million, total stake $ 536.7 million

Not all of the activity has been disclosed. In the 2nd quarter of 2013, apparently some activity was kept confidential. Berkshire's latest filing says: "Confidential information has been omitted from the public Form 13F report and filed separately with the U.S. Securities and Exchange Commission."

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

This makes sense because the total value of disclosed purchases in this 13F-HR do not come close to equaling the total purchases indicated by the Consolidated Statement of Cash Flows in their latest quarterly results.

Reduced Positions
Moody's (MCO): Sold 3.5 million shares worth $ 228.8 million, total stake now $ 1.6 billion
Mondelez International (MDLZ): 6.5 million shares worth $ 204.6 million, total stake $ 18.3 million
Kraft Foods Group (KRFT): 1.4 million shares worth $ 77.8 million, total stake $ 10.6 million
GlaxoSmithKline (GSK): 34.5 thousand shares worth $ 1.8 million, total stake $ 76.6 million

Sold Positions
Gannett (GCI): 1.7 million shares worth $ 44.6 million

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio, even if they still manage only a small percentage of the overall portfolio.

These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer, and technology stocks (primarily IBM).

1. Wells Fargo (WFC) = $ 20.0 billion
2. Coca-Cola (KO) = $ 15.8 billion
3. IBM (IBM) = $ 12.8 billion
4. American Express (AXP) = $ 11.5 billion
5. Procter and Gamble (PG) = $ 4.3 billion

As is almost always the case it's a very concentrated portfolio.

The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus cash and cash equivalents, fixed income, and other investments.**

The combined portfolio value (equities, cash, bonds, and other investments) was roughly $ 200 billion at the end of the most recent quarter.

The portfolio, of course, excludes all the operating businesses that Berkshire owns outright with ~ 290,000 employees.

Here are some examples of the non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, and Oriental Trading Company.
(Among others.)

In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.

See page 106 of the annual report for a full list of Berkshire's businesses.

Adam

Long positions in BRKb, KO, WFC, AXP, PG, USB, and GSK established at much lower than recent market prices. Also, new small long position in IBM established near recent market prices.

* All values shown are based upon yesterday's closing price.
** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Investments in things like preferred shares (and related warrants) are also not included in the 13F-HR.
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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, August 14, 2013

Washington Post Sold To Jeff Bezos

The Washington Post Company (WPO) recently announced they are selling their flagship newspaper to Jeff Bezos in a transaction that should close later this year. It's an apparent case of realizing it was time to sell an asset that -- considering its history and the Graham family's strong ties for decades -- in a perfect world they'd rather not ever have to sell.

I mean, it's not like that newspaper is just any asset for the Graham family.

If it weren't for responsibility to the other public owners, and probably if a more obvious solution to the paper's current problems were apparent, this surely wouldn't have occurred.

I'd offer that it's not hard to imagine executives and board members at some other companies behaving very differently -- while creatively justifying their actions -- under the same circumstances.
(Explanations and justifications that might attempt to cleverly shroud the real reasons for action -- or, depending on the circumstances, inaction -- more or less at the expense of shareholders.)

With that in mind what has been done here appears rather impressive.

Actually doing what's in the best interest of shareholders.

Unfortunately, all too often, that's just not what happens.

They've sold the paper to someone with a very different set of capabilities and constraints. The unique talents and characteristics of Jeff Bezos naturally played a role.

Washington Post Company chairman and chief executive Donald Graham and publisher Katherine Weymouth made that clear.

Also, Warren Buffett apparently called Jeff Bezos "the ablest CEO in America."

Quite an endorsement. It really isn't easy to think of a better CEO in terms of proven ability to disrupt in smart ways, and a willingness to build something for the long-term (though there are no doubt quite a few very good CEOs that can compete for that characterization). Still, Bezos deserved respect and admiration has been well-earned over the years.

Amazon's (AMZN) stock is another story...*

In prior posts I've highlighted the impressive abilities of Mr. Bezos while, at the same time, saying I didn't at all care for the stock on a risk-adjusted basis relative to alternatives.

It's not that I don't think the stock might be intrinsically worth quite a lot some day; it's that achieving very attractive returns bought near its recent (or even much lower) market valuation depends on continued very good -- even transformative -- things continuing to happen.
(Things that Bezos, considering the track record, will probably even pull off.)

It's also that the company is difficult to intrinsically value (what its true earnings power is and how it will likely change within a reasonable range isn't at all obvious -- at least compared to some others) and, as a result, figure out what the appropriate discount should be. At least it is for me. If you can't figure out the likely value within a reasonable range, it's obviously not possible to figure out what the right discount to pay for that value should be. Someone else, of course, may be able to judge these things well and, as a result, might find Amazon to be an appropriate investment for them.**

To me, when it comes to Amazon, it's just not obvious that the return will be sufficient considering the risks and compared to alternatives. Consideration of opportunity costs is always an all-important part of the investment process.***

Investments occasionally come along that are priced such that nothing extraordinary has to happen to get a great result. That's more my kind of investment.

Margin of safety.

Still, that point of view on a stock -- right or wrong on my part -- shouldn't get in the way of admiring someone's skills as a CEO.

Sometimes, the "halo effect" can cause one to make that kind of misjudgment.

It's just best to be aware and wary of that potential effect.

Corporations more than occasionally end up with a CEO who behaves in a way that isn't near optimal for those who actually own the company. A CEOs mind is no less prone than the rest of us to things like, for example, "self-serving bias" and the many other behavioral biases that lead to less than optimal judgments on behalf of investors.

"On a subconscious level, your brain plays tricks on you and...it's very hard to deal with since it's not conscious malevolence that's causing the bad cognition -- it's the subconscious reality of the human mind." - Charlie Munger at Harvard-Westlake School

So the bad outcomes aren't always going to be conscious and intentional.

The sale price for the Washington Post's soon-to-be former newspaper seems a very fair one considering the circumstances though, for very different reasons than Amazon, figuring out what it's actually worth is also difficult at best. Still, the deal might be a better one for Bezos than it first appears. Check out this The Atlantic article for more details on the reasons why.

The article points out that it mostly comes down to pension obligations. The terms of this deal have been structured so the pension costs associated with the newspaper essentially remain obligations of the to-be-renamed Washington Post Company and not Jeff Bezos.

The good news for continuing Washington Post Company shareholders is that the company's pension plan is, as this Barron's article points out, very much overfunded.

There's no shortage of companies that can't come close to claiming such a thing.

In any case, only with the benefit of hindsight will the merits of this deal, and challenges for the paper itself, become more understandable.

Adam

Small long position in WPO; no position in AMZN

Related posts:
Amazon, Apple, and Intrinsic Value - Part II
Amazon, Apple, and Intrinsic Value
Negative Working-Capital Cycle
Amazon, Apple, and Margin of Safety
Amazing Amazon
Barron's on Bezos: Time to Reign in Amazon's CEO?
Amazon's Jeff Bezos On Inventing & Disrupting
Amazon Sells Kindle Fire Below Cost
Technology Stocks

* I realize there are some strong views about Jeff Bezos and Amazon's stock. I happen to admire what Bezos has accomplished as a business leader overall. I won't be surprised if Amazon ends up being intrinsically worth a whole lot. This might seem at odds with my lack of interest in the stock as an investment, but it simply gets back to knowing what you know and, if you can't pin down the valuation within a reasonable range (as is the case for me when it comes to Amazon), there's no way to figure out what price represents an appropriate margin of safety. That's the primary reason I haven't owned it. For me, shares would need to sell at a plain discount to a more straightforward to estimate value in order for it to be of interest. The shares would also have to look attractive against well understood alternatives. Those who are more comfortable estimating Amazon's intrinsic value are naturally better candidates for long-term ownership. (I've never had -- and will never have -- views on trading price action on ANY stock even if it happens to be over a longer time horizon.) Still, much can be learned from Bezos and Amazon whether or not one is comfortable with owning the stock.
** As always, I have zero opinion on what any individual stock price might or might not do in the next month, year, or even 5 years for that matter. Price action -- no matter how exciting -- is of little interest to me. I'll leave it to others to try and play that game. I'm sure many do that sort of thing well and, well, best of luck to them. It's just a different game altogether. My interest lies in judging what something I happen to understand is intrinsically worth, how that value is likely to change within a reasonable range over time, then paying a clear and substantial discount. That's difficult enough to do consistently and effectively. Judge price versus value well and the rest, at least over the long run, usually takes care of itself. The price eventually roughly tracks per share intrinsic business value even if a disconnect between price and value occasionally persists -- sometimes even for many years. If price persistently doesn't reflect full per share business value that disconnect should be of little concern for the long-term investor. (In fact, such a situation can prove a net benefit for continuing owners if it allows more stock to be bought or bought back cheap.) Now, if price persistently far exceeds per share intrinsic business value that's a whole different ballgame.
*** Charlie Munger at Harvard-Westlake"About the 20th page of [Greg] Mankiw's famous book...the guy says smart people make their decisions based on opportunity costs. Well, that was the last time opportunity cost was discussed in 1,000 pages. I want to tell you that compared to the other drivel that was discussed, opportunity cost deserves more than one sentence."
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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.

Friday, August 9, 2013

Efficient Markets - Part II

A follow up to this post.

Warren Buffett wrote the following about efficient markets in the 2010 Berkshire Hathaway (BRKa) shareholder letter:

"John Kenneth Galbraith once slyly observed that economists were most economical with ideas: They made the ones learned in graduate school last a lifetime. University finance departments often behave similarly. Witness the tenacity with which almost all clung to the theory of efficient markets throughout the 1970s and 1980s, dismissively calling powerful facts that refuted it 'anomalies.' (I always love explanations of that kind: The Flat Earth Society probably views a ship's circling of the globe as an annoying, but inconsequential, anomaly.)"

Well, they may have clung to the theory in the 1970s and 1980s, but it is 2013 now. Sometimes ideas -- and occasionally even the not very good ones -- have a funny way of being persistently influential.

In other words, it used to seem surprising that a plainly flawed theory would continue to be taken seriously over such a long period of time.

Not anymore.

I've come to almost expect it and suspect that certain institutional dynamics -- with an assist from some forms of psychological bias -- contribute greatly to this.

From the prior post:

...for lots of reasons, too many participants tend to underperform and that's likely to continue. There would seem to be little doubt about that considering the evidence. As I see it, here's the problem and where the disagreement begins:

When someone -- I think it is fair to say -- rightly points out how difficult it is to outperform the market over the long haul, it seems the default primary reason offered is often the inherent efficiency of markets.

At first glance seems reasonable enough yet that, I think, is not just somewhat incorrect but, more or less, a grossly wrong conclusion.

...and later in the same post:

The inevitable reality is that, in aggregate, market participants can only produce the market returns minus frictional costs. That doesn't mean it's not worthwhile to reduce the adverse effects, where possible, of the many behaviors that get market participants into trouble or otherwise hurt results; that doesn't mean it's not worthwhile to seek improved capabilities among market participants.

Participants do tend underperform but it's not due to the efficiency of markets. Some of it comes down to investment skill; some of it, temperamental and psychological factors. Our minds are susceptible to a variety of cognitive biases and emotional biases and other behavioral tendencies that can adversely impact results. The misjudgments that result from these biases can be mitigated (at least they can be to an extent via an appropriate trained or learned response), investment skills can be improved, but it all starts, of course, with understanding it's even worth trying to do so.

"...academics at prestigious business schools...were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value - and even thought, itself - were of no importance in investment activities." - Warren Buffett in the 1985 Berkshire Hathaway Shareholder Letter

Buffett: Indebted to Academics

This helped to propagate the more than a little flawed idea that essentially concluded there's no point in even trying to think about business value because the price is always right or, at least, always very nearly right. Efficient market hypothesis (EMH) more than suggests it's better to not even try to understand why Buffett, Munger, and, actually, a number of others have invested so effectively long-term.

Now, attempting to combat those things that tend to get investors into trouble hardly guarantees improved individual performance over the long haul. That's just the reality. Long run outperformance, with all risks considered, just isn't an easy thing to do. Yet, to me, it does seem likely that having a critical mass of market participants (or, at least, a meaningfully higher proportion than what we have now) more oriented toward (and skilled at) judging price versus value -- or, at least believing it was worth trying to do so -- might just reduce the number and degree of mispriced assets in capital markets. More emphasis by more participants on long-term effects with less betting on short-term noise and price action -- whether fundamentally or technically based -- certainly couldn't hurt. The same goes for participants being more aware of and learning to control, at least to an extent, the many psychological factors that do the most damage to results.

It might even make bubbles of various kinds at least somewhat less likely.

If so, it should also mean less frequently misallocated capital, reduced frictional costs (if there were fewer "stock-renters" and, instead, more long-term oriented stock ownership), and a system that serves the world a whole lot better than it currently does.

"...if you call investment fulfilling the basic function of the financial system, and that is directing capital to its highest and best uses, you're talking about money [that] gets directed in new ventures, existing companies, innovative companies, whatever it might be. And that has been running about $250 billion a year. How do you measure speculation? [You do so] by the amount of trading that goes on in the market, and that's around $33 trillion a year." - John Bogle in a Morningstar Interview

There'll always be a room for speculation.* Yet having a larger percentage of market participants anchored by how per share intrinsic value compares to share price, possessing not just investment acumen but also sound business skills and judgment, while being more aware of the emotional and psychological factors that hinder long-term performance can't be a bad thing for civilization.**

Though, with fewer mispricings, it seems likely that it would become more difficult for individuals to outperform. Not such a bad thing for the world, even if it makes life harder for individual market participants to outperform.

This seems hardly like a problem at all. If investors mostly made their returns from real increases to per share intrinsic business value, less from other factors, maybe some very talented people would focus their energy on something more useful than the frequent trading of marketable stocks and related activities.

Whether the holding period is measured in seconds, minutes, days, weeks, months or even a year less of that sort of thing would be progress.

I'm thinking many years from now we'll still have faithful adherents to the idea of efficient markets (and related modern financial theory) despite the available contradictory evidence.

Unfortunately, it's unlikely that their influence will be diminished anytime soon.

This isn't to argue -- and I mentioned this in the prior post -- in favor of buying individual stocks. It's rather just the opposite.

John Bogle thinks most investors would be better off consistently buying broad-based index funds over time. There is no shortage of evidence to support his sound advice. It's, in fact, pretty overwhelming. Yet, there'll still be no shortage of participants who continue to kid themselves that, over the long run, they can outperform by buying individual stocks over the long run.

Some can and will outperform long-term, of course, but it seems probable that too many who should be taking Bogle's advice will continue to ignore it.

Only after a very long measurement period -- along with, considering the risks, careful objective comparison of results to an appropriate benchmark -- will it become clear that bothering with individual stocks was worth the trouble.

That reality just doesn't logically lead to the conclusion that markets must be efficient.

Adam

Long position in BRKb established at much lower than recent prices

Related posts:
-Risk and Reward Revisited
-Efficient Markets
-Modern Portfolio Theory, Efficient Markets, and the Flat Earth Revisited
-Buffett on Risk and Reward
-Buffett: Why Stocks Beat Bonds
-Beta, Risk, & the Inconvenient Real World Special Case
-Howard Marks: The Two Main Risks in the Investment World
-Black-Scholes and the Flat Earth Society
-Buffett: Indebted to Academics
-Grantham on "The Greatest-Ever Failure of Economic Theory"
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind

* This includes even those who happen to use fundamental analysis to try and do so. Some think that if fundamental analysis is being used it must be investment. Well, investment has as its focus what a productive asset will produce over very long time horizons. Speculation does not. It's focus is mostly on price action. There's nothing wrong with speculation but it has less in common with investment than some think (even if there's no clear cut line that separates the two activities and they sometimes overlap). There will always be room for speculation especially on the shares of businesses with inherently more unpredictable future outcomes. Some proven businesses have a rather narrow range of likely business value while others naturally do not. There are, of course, plenty of very capable, long-term oriented, market participants. I'm merely suggesting the markets would function at a higher level if there was a greater proportion of participants focused on effectively judging price versus value and long-term effects; a greater proportion acting like owners instead of renters. Basically, that equity markets would better serve their real purpose -- that is, making sure capital is effectively formed in sufficient scale and allocated to the best possible use -- if there was less short-termism. Equity markets are also, as John Kay says, better able to "sustain high performing companies" when they're functioning well. That means having investors who, by and large, are willing to think beyond the next quarter or two. With any system, even a comparably simple one, the proportion matters. I mean, it's not like a petrol engine functions all that well if the air-fuel ratio strays too far from optimal (and, eventually, it won't function at all if there's too much of either substance). If allocating capital well and high long run company performance are the primary goals then, in their current form, the equity markets seem likely to have far from the optimal ratio of speculation relative to investment.
** Even if, considering human nature, capital markets will likely always be unpredictable and volatile. That doesn't mean attempts to make it less so aren't worth the trouble. Some of this comes down to system design but a whole lot of it comes down to the market participants themselves. Human nature, as well as an inherently uncertain world, assures there is no such thing as a precisely knowable correct price. So the market will never provide perfect prices. Participants in the capital markets will always be susceptible to individual behavioral bias as well as herd behavior -- cognitive, emotional, and social psychological forces. Investing is messy even at it's best. In an always uncertain world, too many unknowns exist to be able to ever pin down the precise intrinsic value of an asset. Certain inherently speculative assets will always have the widest range of possible values and market price fluctuations. Value and price are two entirely different things. A dominant snack food company certainly has a much narrower range of outcomes than some tech startup. As a result, market prices will fluctuate more for the latter. That increase in price fluctuations does not necessarily imply increased returns as some modern financial theory might suggest.
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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, August 7, 2013

Berkshire Hathaway's Second Quarter 2013 Results

The following summarizes what Berkshire Hathaway's (BRKa) operating earnings looked like compared to a year ago in its latest quarterly earnings release:
                                                  Second Quarter                 First Six Months
                                                  2013        2012                    2013        2012
Operating earnings         $3,919     $3,720               $7,701    $6,385

Unfortunately, short-term changes in operating earnings at Berkshire (and, for that matter, most businesses) reveals only so much about how the company is doing in terms of changes to its intrinsic value.

It turns out that book value is a far more useful measure -- even if understated and far from perfect -- when it comes to roughly estimating the percentage change to Berkshire's intrinsic business value.

This should seem at least somewhat odd because book value as a measure tends to be pretty useless with most other companies.

From the 2011 Berkshire Hathaway shareholder letter:

"We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values."

So, if book value were to increase by several percent, for example, chances are intrinsic value increased by roughly the same amount.
(As Buffett points out, it's impossible to know intrinsic value within any precision. It's necessarily approximate but, with some work, a rough but meaningful estimate of value can be made.)

Berkshire's intrinsic value is generally higher than book value.

This happens to be the case primarily because many of the businesses Berkshire owns are intrinsically worth more than the carrying value on the books.

Economic value exceeds accounting value. A reflection of the inherent limitations of accounting more than anything else.

The company's latest results did reveal a noteworthy increase in activity in the area of equities. It turns out that Berkshire bought $ 4.64 billion in equities in the second quarter of 2013.*

That compares to just $ 1.85 billion in the second quarter of 2012.

Also, $ 781 million in equities were sold during the most recent quarter. That number is much lower than the $ 3.01 billion in the second quarter of 2012.

Overall, net purchases of equities for the first six months of 2013 was $ 4.60 billion compared to $ 1.45 billion for the first six months of 2012.

Berkshire also completed the Heinz deal during the quarter. That represented another $ 12 billion plus of investment in equity securities by the company (though not publicly traded).

We should know more about the specifics of the publicly traded equities (at least those listed on exchanges inside the U.S.) that were bought during the quarter when the second quarter 13F-HR is released later this month.**

Though a detailed summary of the specific stocks bought and sold is not provided in the quarterly results, Note 5 in their 10-Q does summarize Berkshire's investment in equity securities under three categories:

- Commercial, industrial and other
- Consumer Products
- Banks, insurance and finance

Well, which specific stocks were bought and sold may not be knowable, but it's worth pointing out that Note 5 shows a nearly $ 4 billion increase to the cost basis of the Commercial, industrial and other category during the 2nd quarter.
(The cost basis for this category during the 1st quarter of 2013 was little changed. So the change in cost basis for the category since the beginning of the year is pretty much the same.)

Note 5 also shows a more modest but still meaningful roughly $ 900 million increase to the Banks, insurance and finance category (a ~ $ 1.66 billion increase since the beginning of the year) along with a $ 102 million drop in consumer products category (a ~ $ 274 million decrease since the beginning of the year).

So it at least hints at the direction they went during the quarter with common stocks. Again, the 13F-HR should reveal much more.

Back to book value. Since the beginning of this year, Berkshire's book value per Class A equivalent share increased 7.6% and now sits at $ 122,900 per share.

Warren Buffett and Berkshire's Board of Directors have made it clear that they are willing to pay up to 120% of the company's book value.

This equates to $ 147,480 per share based upon Berkshire's end of quarter book value. That's what they're willing to pay not what they think the shares are worth.

Naturally, $ 147,480 is not where Warren Buffett and Charlie Munger would peg Berkshire's approximate per share intrinsic value as of now. They'd only be willing to buy the shares at 120% of per share book value if they viewed that resulting price to be cheap compared to current per-share intrinsic value.

Buffett and Munger clearly think intrinsic business value is more than the 120% of book value and, of course, quite a bit more than book value.

So, for a variety of reasons, Berkshire's per-share intrinsic value per share is nicely higher than per-share book value. Still, estimated per-share intrinsic value shouldn't be thought of as an exercise in precision. Intrinsic value is, instead, more likely always a range.

In estimating intrinsic value, the best that can be expected is getting it roughly correct yet meaningful.

Check out the Berkshire owner's manual for a further explanation of why estimation is necessarily imprecise and why Berkshire's intrinsic value exceeds its book value.

"...intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover – and this would apply even to Charlie and me – will almost inevitably come up with at least slightly different intrinsic value figures."

Precision, especially when it is of the false variety, is neither needed nor desirable. This necessary imprecision is where margin of safety comes into the investment process.

More from the Berkshire Owner's Manual:

"Inadequate though they are in telling the story, we give you Berkshire's book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire's intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value."

Though very important, if a stock sells at a nice discount to value, that isn't, in itself, a sufficient reason to repurchase shares.

As Charlie Munger previously explained, investment decisions always come down to opportunity costs.

"About the 20th page of [Greg] Mankiw's famous book, which succeeded [Paul] Samuelson's famous book, the guy says smart people make their decisions based on opportunity costs. Well, that was the last time opportunity cost was discussed in 1,000 pages. I want to tell you that compared to the other drivel that was discussed, opportunity cost deserves more than one sentence." - Charlie Munger***

The reality is, a repurchase only makes sense if a company is in a comfortable financial position, the business itself has what it needs to remain well-fortified against competitors, and that use of capital is truly superior to well understood investment alternatives.

Berkshire's stock closed yesterday at $ 176,855 per share. So it is selling well above where a buyback would even be considered.

That doesn't mean it's necessarily selling above per-share intrinsic value but, at a minimum, it probably does mean the margin of safety is insufficient.

It also likely means that repurchases are less attractive against alternatives.

Adam

Long position in BRKb established at much lower than recent market prices

* See Consolidated Statement of Cash Flows. The second quarter 10-Q shows the first six months of operating, investing, and financing cash flows. Well, that means that under cash flows from investing activities the total purchase of equity securities during the first six months has to be subtracted from purchase of equity securities found in the first quarter 10-Q (which, of course, shows the same number for the first three months). The same is true for the sale of equity securities, of course.
** Though there is no guarantee since Berkshire can, at times, obtain approval to delay disclosure under certain circumstances. Occasionally, the SEC allows the company to temporarily keep certain moves in the portfolio confidential. The permission is granted when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.
*** Munger is referring to the leading textbooks in introductory economics written by Mankiw and Samuelson. He also said the following about opportunity costs back in 2006: "In the real world, you uncover an opportunity, and then you compare other opportunities with that. And you only invest in the most attractive opportunities. That's your opportunity cost. That's what you learn in freshman economics. The game hasn't changed at all. That's why Modern Portfolio Theory is so asinine."
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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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