Tuesday, 22 April 2014 - 20:00

 

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Seed Weekly - Value Investing the Buffett Way (Part 6 2003 ? 2007)

2003 marked the first positive year on the S&P500 following the Dotcom bubble. The US stock market experienced another bull market period leading up to the start of the financial crisis in 2007.

By this time Warren Buffett has been around for so long that he has a very good feeling for the market and also for big US companies. During 2003 he mentions of his purchase of McLane, a subsidiary of Wal-Mart: “We did no “due diligence.” We knew everything would be exactly as Wal-Mart said it would be – and it was.” For Buffett – it’s much more than just a company he purchases – it’s a belief in their management, integrity and product.

He wants to be able to make a character judgement on the company and its management and preferably management must own a stake in the business. “Charlie and I love such honest-to-God ownership. After all, whoever washes a rental car?” He praises the owner of one of Berkshire’s star companies, the Belarus-born “Mrs B” who died during 2003 at the age of 103 and had worked until her death. Her company motto was “sell cheap and tell the truth”. Being a low cost producer demands success, but if a business requires a superstar manager to produce great results, the business itself cannot be deemed great. “The company should be simple that it can be run by a monkey”. Unfortunately, finding these businesses is not that common and Mr Buffett admits “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”

Interestingly, during 2003 Berkshire Hathaway sent the US Treasury $3.3 billion for tax on its 2003 income, a sum equalling 2½% of the total income tax paid by all US corporations. In contrast, Berkshire’s market valuation at that time was about 1% of the value of all US corporations. “Our payment will almost certainly place us among our country’s top ten taxpayers.”

Berkshire ended 2004 with $43 billion of cash equivalents, not a happy position. “Charlie and I will work to translate some of this hoard into more interesting assets during 2005, though we can’t promise success”

As always, Mr Buffett makes investing into stocks seem so simple. In his 2006 letter he tells the story of one of his long-time friends, Walter Schloss, who managed a remarkably successful investment partnership. He didn’t take a dime unless his investors made money. Walter did not go to business school, or for that matter, college. His office contained one file cabinet in 1956; the number mushroomed to four by 2002. Walter worked without a secretary, clerk or bookkeeper, his only associate being his son, Edwin, a graduate of the North Carolina School of the Arts. “We try to buy stocks cheap.” He built this record by investing in about 1,000 securities, mostly of a lacklustre type.

“So much for Modern Portfolio Theory, technical analysis, macroeconomic thoughts and complex algorithms. Walter produced results over his 47 years that dramatically surpassed the S&P 500. And what did members of the academic community do when they were exposed to this new and important evidence? Unfortunately, they reacted in all-too-human fashion: Rather than opening their minds, they closed their eyes. To my knowledge no business school teaching Efficient Market Hypothesis made any attempt to study Walter’s performance and what it meant for the school’s cherished theory. Walter meanwhile went on over performing, his job made easier by the misguided instructions that had been given to those young minds.” Buffett frequently made known his thoughts on investment academics and participants.

By the time that his 2007 letter was published the credit crisis had started. Just about all Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shovelled out money, confident that house price appreciation would cure all problems. Some major financial institutions experienced staggering problems because they engaged in “weakened lending practices”. “It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.” The next article will cover this crisis in more detail.

Kind regards

Lourens Rabé

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 22 Apr 2014

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