My Review of Brett Gardner's "Buffett's Early Investments"

 A Nerdy Look at Buffett’s Early Investments

Investment analyst Brett Gardner did yeoman’s work in piecing together Warren Buffett’s investment process in the early days of his career, first as an individual investor and later through his partnerships.  He went through contemporaneous annual reports, Moody’s manuals, and news stories from the early 1950’s to the mid-1960’s to understand what information Buffett had available to him at the time he made his investments. 

He also availed himself of previously published biographies of Buffett which brought out the legwork Buffett undertook by going beyond the numbers in talking to the managements, employees, and customers of the firms.  Further, he investigated the history, and the managements of the companies Buffett invested in. His is the work of a truly obsessive finance nerd and the reader is the beneficiary of his work.

Gardner investigated 10 investments a few of which I never heard of, such as Marshall-Wells and Cleveland Worsted Mills and several that I am familiar with including Studebaker, American Express and Disney. We should note that Buffett was and is a generalist. There is no industry theme associated with his investments.

Buffett, being a student of the great Benjamin Graham (See: https://shulmaven.blogspot.com/2023/08/my-review-of-seth-klarmans-ed-of-graham.html) who stressed corporate balance sheets as the central focus of investment analysis. Graham was looking for a margin of safety in buying companies that were trading below the value of their working capital, thereby buying the fixed assets for free. This, of course, was not the only factor, but it was significant.

Buffett’s early investments were balance sheet focused. However, he later focused on the importance of controlling the firm’s capital allocation process and the value intangible assets that did not appear on the balance sheet. In the case of American Express it was its brand name which did not take a hit after the company was victimized by the salad oil scandal of the mid-1960’s. In the case of Disney, it was its film library that was carried on the books at close to zero. Thus, instead of buying average companies at cheap prices, Buffett moved on to buying wonderful companies at a fair price. The other thing that Buffett did was to concentrate his investments. He went all in with some investments accounting for a third of his portfolio.

Now the question remains what an investor can do today. The average investor is not plagued by the curse of bigness. It is very difficult for an individual investment to move the needle in a large fund. Buffett himself has admitted that for years. Next the small investor can find unloved and uncovered stocks not on the radar screen of large institutional investors. Of course, this takes a lot digging and a lot of leg work but can be done. However, the one major disadvantage an investor faces today that Buffet didn’t face in the 1950’s is that the overall stock market is trading at levels where there are few companies that offer the margin of safety that Buffett had when he was starting out.

My Amazon Review of Benjamin Graham's and Jason Zweig's (Ed) "The Intelligent Investor (Rev. Ed.)"

 Margin of Safety

 I just finished rereading “The Intelligent Investor,” a book a I read many years ago and much of its investment insights are still very valid for today. I would note that I was weaned on Benjamin Graham’s “Security Analysis, Principles and Techniques” as an undergraduate at Baruch College. I guess you can say that Graham’s ideas are in my blood. Indeed, just as Graham probed the Standard and Poor’s stock guide, so too did I for many years. Today we have computerized databases.

 The most critical ideas that are useful today include:

·       * A stock certificate is more than a piece of paper; it represents an

      ownership interest in a business.

·      *  Investments should only be undertaken with a quantifiable margin of safety.

·     *   “Mr. Market” who on occasion is manic-depressive allows you to express a view on a stock or a bond every day.

·     *   Despite all of your efforts at security analysis the stock market is loosely efficient making it very difficult to outperform a broad index. Investment success flows from a few very special situations.

·      *  Investors can be characterized as defensive or enterprising, but even for the enterprising investor Graham’s rules are designed to minimize losses through diversification and heeding to margin of safety requirements.

 

As the classic value investor, much of Graham’s work is focused on tangible book value. That metric worked well though the middle of the 20^th Century, but that kept Graham and his acolytes away from growth companies who were powered by intangible capital. Thus, it was hard for Graham to get comfortable with owning many of the growth stocks of his era, but his discipline kept him away from the craziness of the bubbles that occurred in 1961 and in the late 1960’s.  Jason Zweig, the editor of this version discusses at the length the extremes of the late 1990’s dot.com bubble.

 

Graham was fond of public utility shares in the early 1970’s because they traded a low price/earnings and price/book ratios. Unfortunately, he did not foresee the debacle that cost over-runs in nuclear power brought on to this sector. Zweig points this out. Also, Graham really didn’t associate the rise in interest rates in the late 1960’s with the rise in inflation. He characterized common stocks as inflation hedges, which in the long run they are, but that is not necessarily true in the short run as rising inflation propels interest rates higher and price/earnings ratios lower.

 

Then there is a short discussion on Graham’s investment in Government Employees Insurance Co. (GEICO). There his partnership broke his diversification rule by investing 25% of its capital in it for 50% of the company. However, its valuation in terms of earnings and tangible equity was very low. It was his best investment and Warren Buffett, his best-known student, followed him into GEICO and as a result Berkshire Hathaway now owns the entire company.

 

Although the book’s examples are dated, the investing rules outlined here are timeless.

For the full Amazon URL see: Margin of Safety (amazon.com)

My Amazon Review of Justyn Walsh's "Investing with Keynes....."

 

Warren Buffett on the Thames

 

Investment banker and now money manager Justyn Walsh has offered up an overview of the investing style John Maynard Keynes where aside from running his own personal portfolio he invested the endowment of Kings College along with several insurance companies. His record as an investor in the troubled 1930’s was phenomenal.

 

Walsh recounts the influence of Edgar Lawrence Smith’s 1924 classic “Common Stocks as Long Term Investments” which became the great intellectual foundation of the 1920’s bull market. In that book Smith recognized that industrial companies by retaining earnings became compound interest machines. During the 1920’s Walsh characterizes Keynes as a momentum investor and in 1929 he paid the price with severe losses.

 

In the early 1930’s similar to Benjamin Graham he became a value investor seeking out individual securities that he believed sold at a discount to their underlying intrinsic value independent of behavior of the overall stock market. This approach is very similar to that of Warren Buffett. Keynes, also similar to Buffett, believed in running a concentrated portfolio where his best ideas would have a real impact. As with Buffett he believed that less than knowledgeable investors should own a broadly diversified portfolio.

 

My main problem with this readable, but somewhat repetitive book, is that there is no data on the year-to-year performance of the portfolios he was managing and there is no inkling of what securities he actually owned. Further he mentions that Keynes had a less than stellar sell discipline but offers no real proof.  Simply put, Walsh over-promises.

For the full amazon URL see: Warren Buffett on the Thames (amazon.com)

 

 

What is Warren Buffett up to?

Warren Buffett's Berkshire Hathaway recently disclosed new positions in Chevron (CVX) and Verizon(VZ), neither of which are typical Buffett investments. These new positions added to already established positions in ABBVIE(ABBV) and Merck(MRK). What do these four positions have in common? Answer: they are all investment grade and they all sport dividend yields at least twice that of the bonds issued by those companies. Buffett is old enough to remember when stock yields were always higher than bond yields in the years before 1957 when share prices were significantly undervalued.

My guess is that Buffett thinks the shares are undervalued, but the real reason for his purchases is that these equities are really bond substitutes for his insurance company subsidiaries (See Table 1 below). Simply put Buffett is asking the question would you rather own, for example, Verizon stock yielding 4.57% with upside potential rather than the Verizon 1.75s/31yielding 2.26% to maturity. It is a no brainer and sooner or later pension fund managers will soon wake up to this fact. One more thing, Berkshire Hathaway benefits from a 50% dividends received tax deduction making the dividends even more attractive.

                                                                    Table 1.

                     Dividend Yield and Yield to Maturity for Selected Buffett Stocks

Company     Div. Yield     Bond Yield     Issue             S&P Rating

ABBV            4.82%          2.16%            1.75s/31        BBB+

Chevron         5.04             1.94                2.23s/30        AA-

Merck            3.57              1.80               1.45s/30         AA-

Verizon          4.57              2.26               1.75s/31         BBB+     

Prices as of 3/2/21 close.

My Amazon Review of Bruce Greenwald's et.al. "Value Investing: From Graham to Buffett and Beyond" 2nd. Ed.

 

In Search of Value

 

As a value investor, I have the highest respect for Bruce Greenwald and his colleagues. Unfortunately, in recent years value investing has failed to live up to its billing. Indeed, over the past two decades Warren Buffett’s Berkshire Hathaway has performed roughly inline with the S&P 500. (I am a shareholder.) My history with value investing goes back to reading Graham & Dodd in 1964 while attending Baruch College. Further I own the classic 1940 edition of that book and Greenwald’s first edition of this book. Nevertheless, I did find my way to owning Microsoft, Apple, and Alphabet.

 

Nevertheless, Greenwald’s new book is worth a careful read. He is very wise in dismissing modern portfolio theory’s Beta as a measure of risk. Why? The beta measure of risk is independent of stock price. He is also very cautious about using discounted cash flow over long periods of time because the results are extremely sensitive to small changes in the discount and growth rates.

 

Greenwald plows over old ground in his discussion using net reproducible assets and earning power as a method for determining value. He then goes one step further by introducing franchise value into his valuation paradigm. Simply put franchise value is created by the ability of a firm to earn significantly higher returns over its cost of capital over a sustained period. Those returns arise from the existence of a protective “moat” around its businesses. Greenwald also recognizes that over time a firm’s franchise value can decline, and he thus introduces a decay factor to account for this factor.

 

The question arises is why hasn’t value investing been successful in recent years. There are at least two explanations. First is that the economy has shifted from tangible asset based to intangible asset based. That means GAAP accounting does not put on the balance sheet such intangibles as trademarks, patents organizational efficiency and research and development platforms. Greenwald adjusts for these factors, but there is higher error term surrounding the valuation of intangibles than tangibles. Second the Fed’s zero interest rate policy coupled with quantitative easing has likely distorted many of the historical metrics defining value.

 

The book was written before Berkshire Hathaway made its $735 million investment in Snowflake, a cloud computing software company. At Berkshire’s price, the company was valued at $34 billion and had trailing twelve months revenue of just under $500 million. Whatever one can say it is hard to make a valuation case for this company. Nevertheless, the stock more than doubled after Berkshire’s IPO purchase.

 

Greenwald has a very long discussion about Intel, the semiconductor giant, which at times in its history represented true value. He blames Intel’s recent problems on value destroying acquisitions. That is true in part, but Intel’s real problems run deeper. Its franchise value has deteriorated as it vaunted R&D operation failed to keep up with advances made by Applied Micro Devices, Nvidia and Apple. Moreover, its edge in manufacturing disappeared as Samsung and Taiwan Semiconductor surpassed it in the production of the latest generation of chips. In other words, Intel’s “moat” was paved over by competition despite its spending 19% and 22% of revenue on R&D and capital spending in 2019, respectively.

 

An added attraction of the book is that it includes vignettes from star value investors as Warren Buffett, Mario Gabelli, and Seth Klarman, among others. I read the book in the Kindle version; given the number of tables, it would have been an easier read in the hardback version.

 

Lastly, I recently started a position in a stock that currently trades at 10 times earnings and is trading at or below in my estimate, the reproduction costs of its assets. So, hope springs eternal and I will close with the opening quote that Graham & Dodd used in their classic text “Security Analysis: Principles and Technique,” from Horace’s Ars Poetica, “Many shall be restored that now are fallen and many Shall fall that now are in honor.”

For the full Amazon URL see: In Search of Value (amazon.com)

 

My Amazon Review of Michael Batnick's "Big Mistakes: The Best Investors and their Worst Investments"

Learning from the Mistakes of Others

Michael Batnick, the research director at Ritholtz Wealth Management, is teaching us that it is important to learn from the mistakes from some of the most successful investors of all-time. This is not an original concept, but nonetheless it as an important one. Nevertheless my problem with his book is not with Batnick, but with his editors or his lack of editors. There are typos, math errors and outright mistakes (e.g. calling “Supermoney” author Jerry Goodman, Jerry Goodwyn.) Further it would have been very helpful to have stock charts where they would have been relevant.

That said he points out the most common of errors all of us have, even the great ones, in that we are victims of hubris/overconfidence, we get sucked in by the allure of leverage and out of frustration we invest outside of our circle of competence. His many examples include, Jack Bogle, Michael Steinhardt,  Stanley Druckenmiller, John Paulson, the Sequoia Fund, Long Term Capital Management, Bill Ackman and yes, Warren Buffett. In Buffett’s case Batnick believes Buffett became overconfident based on his prior experience in investing in the shoe business with his purchase of Dexter Shoe in the early 1990s. He compounded his mistake by paying in stock that would become more valuable over time only to see the business ravaged by foreign competition.

In cases of Paulson, Druckenmiller and Steinhardt we see them investing beyond their core competencies and the case of Bill Ackman we his very big ego get in the way with his giant short position in Herbalife. Of course leverage and hubris brings down Long Term Capital Management. These are all wonderful vignettes and there is much to learn, but I wish Batnick had a sharp penciled editor.

The full amazon URL appears at: https://www.amazon.com/review/RK8WMG81SKIWB/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv