It is not any secret that the “Oracle of Omaha” keeps his lips rather tight when it comes to revealing, which company he is about to invest in. And with the exposure he is getting, who can really blame him? With his exposure, showing the potential triumphs to the investing public would attract thousands, if not millions, of “hangers on”, who would drive the stock price into levels, he could no longer accept for his stellar portfolio.
So all that a savvy student of Buffett’s strategies is left with, are tons of written materials describing Buffett’s not so recent purchases, and his supposed reasons behind them, as put together by various authors.
One of such books I got recently my hands on is “The New Buffettology” by Mary Buffett and David Clark (not too certain about my celebrity gossip, I think Mary Buffett was, at some time, Warren’s daughter in law) published in 2002.
I must say, that, even though I have read quite a number of similar publications, I found this book both very informative and educational. In one of the key chapters, this book describes the types of companies Buffett keeps his eye on, waiting for Mr.Market to present him with a right price so he can “strike for the fences�?. According to the book his favorite plays are divided into four categories:
Businesses that fulfill a repetitive need with a consumer product with brand name appeal.
The advertising business providing a service that manufacturers must continuously use to persuade public to buy their products.
Businesses that provide repetitive consumer services that people and businesses are consistently in need of.
Low cost producers and sellers of common products that most people have to buy at some time in their life.
In the first category you would include businesses, whose products became almost synonymes for their respective industries. From brand name fast food outlets (’nothing gets used up faster than fast food”) where hungry customers associate the taste of particular food with the company brand name (burger – McDonald’s, fried chicken – KFC, pizza – Pizza Hut), through brand name beverages (beer – Anheuser-Bush, cola – Coca-Cola) and brand name foods (chocolate – Hershey’s, soup – Campbell’s, chewing gum – Wrigley’s) to brand name clothing businesses (jeans – Levi’s, shoes – Nike).
To the second category belong businesses, who make their profits from promoting and advertising products of others. Here you would find all the media companies, such as TV stations ABC, NBC and CBS (”buy a transmitter, build an antenna, plug it into the wall, and you’re in the business”), newspapers (Washington Post) and advertising agencies (Omnicon Group, Ogilvy Group). It is fairly obvious, that if any of the companies in this group manages to secure virtual monopoly in it’s field or area, it will be able to price its services however necessary in order to draw excellent profits year in and year out.
Third category includes companies providing services one will need repeatedly over and over again. Often, but not exclusively, the founding stones of these businesses are “not so sexy” operations such as cleaning, pest control, maid services or lawn care (eg. Service Master, Orkin). Other examples of repetitive, constantly needed services in this group come from tax (H&R Block), credit card (American Express) data processing (Fist Data Corp.) industries. The main idea behind investing
your money here is that “…these companies provide necessary services, but require very little in the way of capital expenditures or a highly paid, educated workforce [and] there is no such a thing as product obsolescence”.
And last, fourth group of Buffett’s potential favorites are businesses, which are not enjoying the brand recognition of category one, however their tightly run operations reduced their production costs (and subsequently their product prices) into such depths, that no other competitor dares to challenge their dominant market positions. These investments are present in many industries, the well know examples are Wal-Mart or Berkshire’s own Nebraska Furniture Mart and GEICO (”as long as people need beds to sleep in and couches to sit on and insurance for their car, these companies will make money. Lots of money, for a very, very, very long time to come”).
As you can see from this brief sample, The New Buffettology does provide you with rather descriptive road map to investing success. Because this book does not only cleverly describe how to identify potentially successful investments the Warren Buffett way but also peppers the slow theory parts with lots of real life examples, it is quickly becoming one of my favorite books on the topic.
This yearly event (wearing the badge of “Woodstock for Capitalists”), regularly attracting the crowds in excess of 25,000 from all over the World and, was held on May 5 at Qwest Centre Omaha, Nebraska with related activities scheduled throughout the weekend.
Even though it has been my long time dream to attend this meeting in person, once again, for various reasons, I was unable to attend and need to rely on third party reports to find out all the news. Needless to say that there is already available quite a few articles on the Net describing the buzz in full and if you have some spare time on your hands I recommend Jeff Matthews’s series Pilgrimage to Omaha: Part I, Part II and Part III.
For the folks who want only the “meaty” bits coming form Warren Buffett himself during the main event – five hours long questions and answers session – here are his latest nuggets of investing wisdom by topic:
Inflation
The best protection an individual has against the inflation is one’s earning power. Everyone possessing specific skills set in a niche market will be able to draw sufficient rewards for his services regardless of prevailing domestic or international economical environment.
As the second best protection, Buffett and his right hand man, Charlie Munger, would suggest the ownership of an excellent business. The seasoned “buffetteers�? would know, that these men define such business as:
having durable competitive advantage providing protection from its competitors
not requiring lot of capital to grow hence generating lots of available cash
being managed by talented and honest people
Private equity takeover craze Buffett is not overly concerned of private equity over-leverage bringing the financial markets to disarray as private equity partnership work on a long term, “locked up�? agreements. Typically such agreements may last around 5 years during which no investor can pulled his/her money out, even if the managers’ performance is quite poor. Effectively such conditions provide for stability of used capital.
The issue Buffett does see in private equity lays in the management incentive structures. Often the managers are encouraged to put their available funds to works even at sub-par rates of return so they can collect hefty rewards and fees. Hence it appears the main goal of a private equity fund is to amass as many assets as possible regardless of their quality, not to perform for its shareholders.
Current stock market pricing Warren Buffett suggested that despite the current pricing levels, if he was given a choice of locking an investment for next ten years at 4.75% (current US Treasury bonds yield) or putting it in stocks of S&P 500 he would choose the latter.
To this, Charlie Munger added that even though these are “…not the times to swing for the fences�?, investors can’t be advised to sit on their hands for twenty years and await the price levels of 1932 or 1974 to return.
It seems therefore, that even though the dirt cheap prices are long time gone, Buffett sees an average investor, who carefully carves his/her portfolio around selected quality businesses, doing reasonably well.
Advice to beginner investors
According to Buffett, the best thing the aspiring investor can do is to simply read everything about investing he/she can find. Apparently this is exactly what young Warren did as, by the age 10, he had already read every book on the topic in Omaha’s public library. Every beginner needs to build a wide base of investing knowledge which will in turn provide him with ability to distinguish between truly valuable and unhelpful.
Buffett also acknowledged, that a book called Intelligent Investor written by Benjamin Graham he had read at the age of nineteen, equipped him with basic investing principles upon which he builds to this day. To him, the two major concepts of this book – thinking of stocks as individual businesses and margin on safety – are as relevant today as they were at the time of writing.
Apart of reading, the beginner should simply take a plunge and invest in a real stock. Paper trading, Buffett said, is like holding hands but actually investing a real capital is like “something else entirely”.
And that is all I have from this year’s Berkshire Hathaway Annual Shareholders Meeting. If you have attended yourself and have something to add or if you do not agree with the points Buffett has made let me know in the comments.
As a devoted value investor I am also a strong believer in Warren Buffett’s Mr. Market theory. To me it often provides a platform to understand otherwise unexplainable share market movements. In this article I would like to point out two very recent examples of Mr. Market striking again on the Australian Securities Exchange.
Yet, every so often, I simply can’t help myself not to peek at the latest share prices and read the latest announcements form my favorite companies. And that is, how I noticed the obscure market behavior I am unable to put down to any other factor than the Mr. Market theory.
Who is Mr. Market?
Mr. Market is an imaginary character, Benjamin Graham’s (Warren Buffett’s teacher and mentor) personification of the stock market. As Buffett mentions in his 1987 Letter to Shareholders (shortened and simplified):
Mr. Market appears daily and names the price at which he will buy your interest or sell you his. Even though [the stock] that you own may have stable economic characteristics, Mr. Market’s quotations will be anything but.
At times he feels euphoric and can see only the favorable factors affecting the business [and therefore] he names very high buy sell price.
At other times he is depressed and can see nothing but trouble for the business and the world. On these occasions he will name a very low price as he is terrified that you will unload [your stock] on him.
Mr. Market strikes again
Now, once we understand the idea, let’s see if we can spot the traces of this fellow, with incurable emotional problems, sneaking around the ASX.
Trace 1:
On 24 April 2007 one of the most outstanding Australian companies Blackmores Ltd. announced its quarterly results posting another of theirs, seemingly never ending, year on year profit increases.
For the initiated Blackmores Ltd is a business established in 1930 and it is still in big part owned by the founding Blackmores family. In the last 10 years, this company was able to continuously increase its market share as well as its earnings, on average generating over 25% return on equity per annum. For more Blackomres Ltd figures read my January 2007 analysis of this company.
So while Blackmores Ltd announced its profit after tax totaling to $11.7 million for the nine months ended 31 March 2006 (16.4% increase on the previous corresponding period, more than they made in whole of the 2005 and over 85% of what they made in 2006 with 3 months in the year to spare!), uninterested Mr. Market leaves its stock price pretty much unchanged, casually lowering it by 4c.
Perhaps the stock price already anticipated such performance or the current valuation (P/E over 23) is already so high, that there is nowhere else to climb?
Trace 2:
On 23 April 2007 one of the largest (if not the largest) cotton grower in Australia Namoi Cotton Limited released “Confirms Strong FY 2007 Result” media announcement, in which it reports better than expected result for year ending February 2007.
The result is slightly below the levels of previous year, however even during the challenging period of water shortages and depressed cotton prices, Namoi makes profit about which most others in the business can only dream.
This, however, is to no taste of Mr. Market, who is seeing only doom ahead and expects the unfavorable weather and cotton market conditions to last forever. He briskly drops 6c of the company stock price, instantly decreasing its market value by about 9%. With this valuation he effectively offers the business for sale at about 70% value of its tangible assets alone.
I can understand, that the drought obviously does have horrendous short term impacts in the affected agricultural areas. But as I see it, agriculture, with its dependence on climate conditions, is only another of those cyclical industries where profits and losses come in cycles. If such companies withstand temporary downturns while following strict borrowing policies, they will, no doubt, see the better times stronger than before.
Use Mr. Market to make money
If you watch Mr. Market in action, you will come to realize, that one should be easily able use his behaviour to one’s own benefit. As Mr. Market does not mind to be ignored, if you feel his offer is not quite right, leave him alone. No doubt he will come back tomorrow presenting you with another one.
Warren Buffett in his own words puts it this way (simplified and shortened):
…the more manic-depressive is [Mr. Market’s] behaviour, the better for you. Mr. Market is there to serve you, not to guide you. It is his pocket book, not his wisdom, that you will find useful. If he shows up in particularly foolish mood, you are free to take advantage of him, but do not fall under his influence.
Indeed if you are not certain that you understand and can value [the stock] far better than Mr. Market, you don’t belong in the game.
Therefore, before you invest, make sure, that your valuation is done correctly and than just look around for the foolish offers.
Do you think that the principles of Mr Market theory are still valid today? Or is this idea long obsolete?
In other news:
Banks are offering variety of loans for different purposes. It is very easy to get bank home loan through out the world especially in United States. Competition in the mortgages market is increasing day by day, so a large number of mortgage brokers are available for consultancy. While in case of second mortgage no body want to hire home mortgage consultant. The central mortgage is among the leading ones who are providing quality consultancy.
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