Showing posts with label Warren Buffett. Show all posts
Showing posts with label Warren Buffett. Show all posts

Wednesday, July 16, 2014

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years

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

Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. Warren Buffett

In 1914, the New York Stock Exchange closed for five months. In 2001, the NYSE, Nasdaq and AMEX were closed for a week. Active stock traders did not make any money during those periods. Dividend investors kept receiving their dividend checks, without interruption.

Investors can buy and sell their stock in an instant. This ability to quickly cash out makes stock investing a preferable option for many investors. Compare this to real estate or a private business, where it might take months in order to buy and sell an asset.

Sometimes however this could be a curse as well. While stocks are a very liquid investment, sometimes investors end up being too focused on short-term price fluctuations, while ignoring fundamentals. During bull markets, investors bid up share prices to unsustainable levels. During bear markets, investors who see their portfolio values collapsing panic and sell at the wrong times. Those investors become too emotional, which creates opportunities for the enterprising dividend investors. The emotional investors tend to forget that stocks are not some lottery tickets or numbers blinking on a computer screen, but ownership pieces of real businesses. In a perfectly rational world, the value of business depends on its current and future estimated earnings powers. This is why when entire businesses are sold to a private buyer, the price paid is usually close to the intrinsic value. However, due to the emotional state of Mr Market, the ownership pieces that are exchanged between stock market participants are frequently mispriced.

Dividend investors know that dividend stocks represent ownership stakes in real businesses. As a long-term investor, your success is dependent on the success of the business. If the business manages to grow earnings per share, it would be worth more and would also be able to distribute more in dividend income.

Dividend investors who embrace a buy and hold mentality have an inherently psychological advantage over the average investor. Dividend investors generate a return on investment every time they receive a dividend payment. As a result, many retirees who are living off dividends, concern themselves with the company’s ability to grow earnings to pay higher distributions, than the stock price of the stock. Astute dividend investors focus on fundamentals, understanding the company’s operations and valuing the business as if it were a privately owned corporation.

Dividend investors are in essence much different than the rest of participants, who rapidly exchange little pieces of ownership between each other, in an effort to outwit each other. Dividend investors see stocks as partial ownership pieces of real businesses. They understand that their ultimate success in investment is based on the price they paid and on the success of the business itself. If you own a restaurant along with 10 other partners, you care about making sure the business succeeds, and stays relevant for as long as possible. The goal is to make sure that repeat business is earned, customers are happy, and profit margins are healthy, while trying to constantly increase profits. The advantage of dividend investors is that they focus on the fundamentals of the business, how it earns money, and whether this business has the potential to earn more money in the future. Then they try to purchase that business at an attractive valuation, which takes into consideration a range of potential outcomes, and provide an entry price range which would generate a satisfactory return on investment. If you are the partial owner of a McDonald's franchise, you earn profits whether the stock market is open or closed. In fact, if you have found the right business at the right price, it is highly likely that you will hold this business forever.

This is how I view ownership of high quality companies such as Coca-Cola (KO), Johnson & Johnson (JNJ) and Kinder Morgan Inc (KMI). Those are real businesses, that provide real goods or services to clients, and which generate profits to be distributed to me as the partial share-owner. I expect to hold those businesses forever, and expect to earn ever increasing dividends over time from those ownership stakes. I see the rapid trading as pure madness, which actually doesn't really affect me. Whether I pay $37 for Coca-Cola shares or $37.10/share is irrelevant to me. Let the high-frequency computers make that money. The real money is made by identifying a quality company,  buying it at an attractive price, and then sitting on it for decades. In the meantime, the business will be earning more and more in profits almost every year, and pay you an amount of dividends that will likely exceed the purchase price paid by a factor of a few times the purchase price.  Time is the ally of the long-term, buy and hold dividend investor. The initial results are slow, but eventually, the compounding ends up snowballing into mind-boggling yields on cost and capital appreciation returns.

This is why I spend so much time screening the list of dividend champions and dividend achievers, and then researching companies one at a time. I am looking for companies with strong competitive advantages, strong brands, that would allow those companies to have the potential to be around in 20 years, and still earn more per share over time. For example, if you are a part owner of the local water utility, you know that this business will be around in the next 20 - 30 years, because it would be impossible for someone else to compete with you, due to regulation and cost to set-up and maintain the system. If you are a part owner in a company that provides a unique product or serves, which is largely unregulated, it essentially has a monopoly that could mint profits to the shareholder for decades. A prime example of that is Coca-Cola, which has a strong distribution network throughout the world, is associated in consumers' minds with positive emotions, has over 500 brands globally that quench the thirst of people in 200 countries to the tune of 1.9 billion servings per day. If you believe this business has the staying power to be around in 20 years, then you can make projections on earnings, revenues and dividends with a much larger degree of comfort. You want a business which will not change too rapidly. People will get thirsty 30 years from now. If you have the distribution scale that covers 200 countries, and a portfolio of 500 branded drinks, chances are that consumers will use your products. This is why Buffett invests in quality companies with durable competitive advantages, operated by honest and able managers, which have attractive returns on capital and which are available at attractive prices. If you find such a company, the goal of the dividend investor is to hold on to it for decades, and let the power of compounding do the heavy lifting for them.

In contrast, while I might know that Apple will be around in 20 years, I am not so sure how much profitable the enterprise will be, due to the rapid changes in technology. Sony was another great consumer technology franchise, which has not done so well as of the past decade. Will Apple follow the steps of Sony? I don't know, and chances are that few investors really have the necessary knowledge to make an educated bet today. This is why I am sticking to companies I understand, and focus on their fundamentals for the next 20 - 30 years. As a long term buy and hold dividend investor, my goal is to live off the dividends from my collection of quality enterprises. Therefore, my success will be determined on the success of the businesses I invest in, not on stock price fluctuations. The stock market is only helpful to me as a tool where I find sellers of quality businesses, not as a place to instruct me on how to make my investments.

Full Disclosure: Long KMI, JNJ, KO. One share of BRK.B

Relevant Articles:

Coca-Cola: A wide-moat dividend growth stock to buy and hold
Maintaining Moats in times of Technological Changes
Seven Sleep Well at Night Dividend Stocks
How to analyze investment opportunities?
Let dividends do the heavy lifting for your retirement

Thursday, July 3, 2014

How to earn $900 in dividend income per minute

On July 1, Buffett’s Berkshire Hathaway (BRK.B) received $122 million dollars in dividend income from their 400 million shares of Coca-Cola (KO). This comes out to roughly $928 dollars in dividend income for Berkshire Hathaway every minute, or almost $15.47 every single second. Those shares have a cost basis of $1.29 billion dollars, and were acquired between 1988 – 1994. The annual dividend payment produces an yield on cost of over 37.50%. This doesn’t assume dividend reinvestment and is 4 – 5 times higher than what investors in 30 year US Treasuries would be earning. This is why I believe that Warren Buffett is a closet dividend investor.

This is a testament to the power of long-term dividend investing, where time in market is the investors best ally, not timing the market. If you can select a business which is run by able and honest management, which has solid competitive advantages, and which is available at a good price today, one needs to only sit and let the power of compounding do the heavy lifting for them. As Buffett likes to say, time is a great ally for the good business. In the case of Coca-Cola, the past 26 years have been a great time to buy and hold the stock. The company has been able to tap emerging markets in Eastern Europe, Asia, Africa and Latin America like never before. As a result, it has been able to receive a higher share of the worldwide drinks market, which has also been expanding as well. If you add in strategic acquisitions, new product development, cost containment initiatives and streamlining of operations, you have a very powerful force for delivering solid shareholder returns. With dividend investing your are rewarded for smart decisions you have made years before.

If they closed the stock market for a period of 10 years, Coca-Cola would be one of the companies I would be willing to hold on to. This is because ten years from now, the company would likely be earning double what it is earning today, and would likely be distributing twice as much in dividend income than it is paying to shareholders today. Check my analysis of Coca-Cola for more information.

At the end of the day, if you identify a solid business, that has lasting power for the next 20 – 30 years, the job of the investor is to purchase shares at attractive values, and hold on to it. This slow and steady approach might seem unexciting initially, but just like with the story of the slow-moving tortoise beating the fast moving hare, the power of compounding would work miracles for the patient dividend investor.

Currently, Coca-Cola is selling for 20.20 times forward earnings and yields 2.90%. This dividend champion has managed to increase dividends for 52 years in a row. Over the past decade, Coca-Cola has managed to increase dividends by 9.80%/year, equivalent to dividend payments doubling every seven years. This is much better than the raises I have received at work over the past decade, despite the fact that I have routinely spent 55 - 60 hour weeks at the office.

Full Disclosure: Long KO and one share of BRK.B

Relevant Articles:

Coca-Cola: A wide-moat dividend growth stock to buy and hold
Warren Buffett Investing Resource Page
Seven wide-moat dividends stocks to consider
Warren Buffett’s Dividend Stock Strategy
The importance of yield on cost

Wednesday, March 12, 2014

I admire Investors with Skin in the Game

Anytime I study companies for a potential investment, I always try to do plenty of research on the company, reading annual reports, analyst reports and articles on the firm. Many times I end up reading very positive articles where owning company’s shares is mentioned as a no-brainer decision. After reading the articles however, I am always surprised when authors are not owning shares in this otherwise slam-dunk investment.

That being said there are valid reasons for not owning a company's stock, such as waiting for a pullback or due to conflict of interest. Either way however, I prefer to listen to an investor who has skin in the game. Authors who are good at writing articles, have very little to teach me about investing, where the major part of success is based on investor psychology, rather than neatly organized content. I believe in learning from those who practice their skills, not those who claim to have knowledge of it. After all, if you went for a surgery, would you go for the person that has all the theoretical knowledge, or would you go for the person who has actually practiced their skill?

I do not trust financial advisers whose goal is to sell you products you do not need. I cannot trust a college kid with a degree who has never dealt with psychological dilemmas of investing decisions. I enjoy reading articles written by authors who talk about their own experiences as investors.

I also prefer books from authors who have made it in the investing game, or at least discuss a particular topic from their own experiences. If they failed that is fine with me as well. Sometimes you increase your chances of success and gain more knowledge on a given topic when you learn what not to do, rather than what you should be doing. If you narrow down investing books to only those based on personal experience, rather than the academic ones describing your hypothetical returns, you are only left with a handful.

The reason why I prefer following investors with skin in the game is because you view situations differently when money is on the line, rather than using statistics and pie in the sky models. That is why I respect individuals with stake in the game. Warren Buffett for example, the world’s most renowned investor and the chairman of Berkshire Hathaway (BRK.B) is the epitome of an individual with a stake in the game, who have always treated investors that have trusted him with their money as partners, and looked after their best interests. He made a lot of money for himself in the process as well.

Richard Kinder, the CEO of Kinder Morgan Inc. (KMI) is another individual that I greatly admire. His interests are aligned with the interests of Kinder Morgan (KMI) shareholders and Kinder Morgan Energy (KMP) limited partners. The higher the distributions that Kinder Morgan Energy Partners achieves, the higher the dividends that this CEO with the sky-high salary of $1/year will receive. Compared to Richard Kinder, even Buffett's $100,000/year salary looks excessive.

Compare this to the typical CEO compensation however, which runs into the millions of dollars, no matter what the financial performance of the company they are heading. Some CEO's spend more time gaming the system, and wasting shareholders' money on ill-timed ego boosting acquisitions or share buybacks, while collecting big paychecks. For example, in 2009 I posted a chart of the CEO's that collected enormous bonuses, while their companies were struggling and had to cut distributions to shareholders.

Full Disclosure: Long KMI and KMR

Relevant Articles:

- Complete List of Articles on Dividend Growth Investor Website
Highest paid CEO’s in 2008 didn’t perform that well as a group
The Importance of Corporate Governance for Successful Dividend Investing
Warren Buffett Investing Resource Page
The work required to have an opinion
-

Saturday, February 8, 2014

Warren Buffett is now working for me

I recently initiated a position in Berkshire Hathaway (BRK.B), which is the holding company of billionaire investor and philanthropist Warren Buffett. Over the past year, I have studied almost everything publicly available on Warren Buffett and how he accumulated his sizeable fortune. This included his early years where he was obsessed with numbers and businesses, his Buffett partnership years, and his latest investments at the helm of Berkshire Hathaway over the past 50 years.

The reason behind my purchase of Berkshire Hathaway is because I want to be able to go to the 2014 Berkshire Hathaway meeting of shareholders in May.There is a 50/50 chance that I will be able to attend the meeting.  I actually purchased just one “B” share with the Loyal3 brokerage service, so technically the amount I invested is immaterial to my net worth. I am a big fan of Warren, and have learned a tremendous amount from his teachings on how to view stocks as ownership pieces of real tangible businesses, not just some abstract concept to speculate on. Incidentally, I have found specific evidence that he is a closet dividend investor, as he is focusing on extracting and deploying excess cashflows from companies he owns into more income generating businesses.

I believe that the Berkshire Hathaway that Warren built from the remains of the old textile mill is a collection of high quality businesses run by good managers. I believe that Berkshire will endure for decades after Warren stops running it. It is very likely that it would be able to at least match the returns of the S&P 500 over the next few decades. However, I would never put a material portion of my portfolio in Berkshire Hathaway. The main appeal behind the company for me would be the man itself, Warren Buffett. Unfortunately, I am not so sure that he would be around for the next 30 years, which is my long-term investing horizon. In addition to that, Berkshire does not pay a dividend, although it might initiate it once the Gates Foundation receives most of it.

That being said, I am writing this post in order to alleviate any potential concerns that I am all of a sudden switching strategies. I am not, and this one share of Berkshire Hathaway is as inconsequential as the silver coin collection that my grandfather gave me several years ago, or the 40 or so euro’s I have left after my trip to Europe last summer. I am also typing this up, because I am slowly trying to be more open on this site, by posting things like recent personal investments for example and my dividend  portfolio holdings.

Relevant Articles:

Warren Buffett Investing Resource Page
Warren Buffett – A Closet Dividend Investor
Warren Buffett on Dividends: Ideas from his 2013 Letter to Shareholders
My Dividend Portfolio Holdings

Wednesday, December 4, 2013

Warren Buffet’s Favorite Exercise

I like learning from super investors of the world. When I think about super investors, the first thought that comes to mind is Warren Buffett.

Buffett’s favorite exercise is going to a certain year, looking at the top 10 - 20 companies by market capitalization, and then determining whether they are still around or not. This fits in perfectly with the long-term investment strategy of the Oracle of Omaha, where he tries to select companies that are still going to be around and doing well 15 – 20 years into the future.

For example, using the Standard & Poor's, I looked at the top ten companies in the index as of 1983:

YEAR
COMPANY
%
MARKET
% OF
8312
Int'l Bus. Machines (IBM)
1
$74,346
6.09%
8312
Exxon Corp (XOM)
2
$32,114
2.63%
8312
General Electric (GE)
3
$26,626
2.18%
8312
General Motors (GM)
4
$23,414
1.92%
8312
American Tel & Tel (T) (new)
5
$17,234
1.41%
8312
Stand'd Oil,Indiana
6
$14,848
1.22%
8312
Schlumberger, Ltd (SLB)
7
$14,503
1.19%
8312
Sears, Roebuck
8
$13,150
1.08%
8312
Eastman Kodak
9
$12,603
1.03%
8312
duPont(EI)deNemours
10
$12,405
1.02%

Thirty years later, only two of these companies went bankrupt (Eastman Kodak and General Motors), while the rest did well for their shareholders. The past 30 years were a tumultuous period for all of the companies however, as it was characterized by a flurry of mergers, acquisitions, reorganizations and changing of business focus. For example, at one point in 1993, International Business Machines (IBM) was very close to falling on the wrong path. In another example, Sears had acquired and then spun-off a handful of companies before merging with Kmart in 2004 to form Sears Holdings (SHLD). An investor who put $1000 equally in each of those ten leading blue chips at the time, did very well 30 years later if they held patiently all the stock they received and reinvested their dividends.

The AT&T you see listed is the long-distance operations of the original Ma Bell, after the split of the 7 regional baby bells. The company was acquired by SBC (one of the 7 baby bells that were split from Ma Bell in 1984) in 2005. Subsequently, SBC changed its name to the AT&T (T) we know today.

Exxon managed to merge with Mobil in 1999, and formed Exxon Mobil (XOM). This was quite interesting, because both companies originated from the break-up of Standard Oil Trust in 1911. You might notice Standard Oil of Indiana in the list, which was also a descendant of the Standard Oil Trust, and was later renamed Amoco. The company was acquired by BP in 1998.

In my investing, I look at the dividend kings, not as a list of recommendation per se, but for learning perspective. It is always a good idea to try and understand how some companies managed to boost earnings, so that they could increase dividends to shareholders for over 50 years in a row. For example, companies like Procter & Gamble (PG) were able to use their scale to their advantage in the new medium of television starting in the 1950s. Then the company managed to ride the wave of prosperity after the fall of the Soviet Union in the 1990s.

Full Disclosure: Long IBM, XOM, PG,

Relevant Articles:

Why Warren Buffett purchased Exxon Mobil stock?
Warren Buffett Investing Resource Page
How Warren Buffett made his fortune
Check the Complete Article Archive

Tuesday, November 26, 2013

Why Warren Buffett purchased Exxon Mobil stock?

I have spent the last year, learning as much as possible about Warren Buffett and his right hand man Charlie Munger. There is plenty of information from both super investors to keep you occupied full-time for months if not years.

The most interesting insight is that if you pay attention to these two investment legends, you can gain a lot of insight about what is going on inside their heads. In addition, by many of their statements, Buffett and Munger can sometimes inadvertently divulge or give away what they think about certain companies, and what they are looking to buy or sell.

For example Charlie discussed US energy independence in a 2013 conference, and some of his statements were widely quoted. While I found his comments to be very weird at the time, I believe Charlie Munger was probably instrumental in the purchase of Exxon Mobil stock in 2013.

Even I succumbed to the frenzy, and dedicated a whole article on the topic. I did not agree with some of his ideas, but concluded that maybe his ideas mean that he is interested in oil as an investment. It seems now that the speech by Munger was definitely inspired by all the research he and Warren had done on the topic of investing in oil. If they spent months researching investments in the oil and gas space, it is not surprise that Munger had oil in his head to talk about. As usual, hindsight is always 20/20 however.

I also previously discussed why the so called peak oil is nonsense. This is because technology is improving, and the ability to discover and tap oil reserves is also improving. Furthermore, as the price of oil and gas increases over time, energy companies would have a higher incentive to explore for energy in areas that are more expensive. In my article I discussed how the estimated reserves of oil and gas left on earth have been increasing over the past several decades.

Another fact that could have shown Berkshire’s intentions that it is researching Exxon Mobil for possible accumulation, is Warren Buffett’s discussion on gold and how he could buy 16 Exxon Mobils and all farmland if he were to own and subsequently sell all the gold in the world. This discussion was listed in the 2011 Letters to Shareholders.

Some of Buffett’s largest buys like Wells Fargo (WFC), Burlington Northern Santa Fe, International Business Machines (IBM), Heinz and now Exxon Mobil (XOM) are truly long-term buy and hold selections. These are core positions, which would likely not be sold for many decades. These are blue chip companies, who will produce an increasing stream of dividends for decades to come to Berkshire Hathaway shareholders. These are the slow and steady type of companies, whose customers repeatedly use their products or services. If you believe the US economy and the World economy are going to be larger 20 -30 years from now, these would be the companies to buy and forget. Once you acquire a shares in a great company at attractive valuations, you can simply afford to sit back and enjoy the dividend checks coming your way for decades. I believe that investing in those companies is one way for Buffett to invest Berkshire’s money for the next generation after him. It is similar to your grandfather leaving his grandson/granddaughter a pile of stock certificates, that would pay for great granddaughters/grandsons college educations. I have analyzed Exxon Mobil before, and have also concluded that it was a sound long-term investment. This is why I have been adding it to my Roth IRA this year.

Essentially, the central idea for buying Exxon Mobil is that oil is a finite resource, which cannot be recovered once it is used up. The easiest oil has already been discovered, leaving oil and gas deposits that are more costly to produce. The world is likely to keep needing carbon energy like oil and gas for several decades, even if renewable energy sources from the sun, wind and water can eventually satisfy worldwide energy demand. This could likely occur in a few decades. Even if that were to happen however, humanity would still need substances like oil, because it is used up in everything that our modern civilization is based upon – plastics, pharmaceuticals, chemicals, etc. Unlike gold however, which is mined and could be reused, once you have used up oil, it is gone forever. You could recycle some of the plastics and other compounds from oil however, but not everything.

Prices for oil and gas will likely increase over time. However, this won’t be a linear and straightforward increase. This would make existing reserves of oil companies like Exxon Mobil more valuable, and its technical know-how of how to successfully explore for and tap reserves, provide it with a competitive advantage in the field. Mostly large companies will be able to succeed in major exploration and production developments in difficult to explore for regions. Their massive scale, access to cheap capital, and experience, will help them overcome the challenges of drilling in inhospitable terrains such as deep seas, and places in the North that have been frozen for millions of years.

Rising prices will likely result in higher profits over time, which would surely result in higher stock prices and higher dividends per share. The company has proven that it is a steward of shareholder capital, as it has managed to increase dividends for 31 years in a row. Over the past decade, Exxon Mobil has managed to also raise dividends at a rate of 9%/year, while also repurchased one third of outstanding shares. As I have mentioned before, Charlie Munger likes carnivores, which are companies that consistently repurchase their shares. IBM and Exxon Mobil are companies with some of the most consistent share repurchases, which didn't stop even during the financial crisis.

If you compare Exxon to the other major energy companies in the world, it is not the cheapest one on the list.


Currently, Exxon Mobil is trading at 12.40 times earnings and yields 2.60%. It is not the best value, based on this table. However, it is the company with the longest streak of consecutive dividend increases. You can probably look equally as well with any of the companies listed above. I am going to speculate why he didn't buy each company, based on information I have gathered from Buffett over the past decade. The likes of Total have withholding taxes, and some uncertainty over increasing taxes for French companies. BP was probably excluded, because of the negative environmental effects of the 2010 oil spill. Buffett probably doesn't want to be associated with this. I am not sure why Royal Dutch was excluded, although it could be due to a scandal a few years ago that had to do with the company overstating reserves. We all know that Buffett wants to deal with able and honest management, and therefore a history of mismanagement of such proportions could be a red flag. This could be a red flag, even if the company has gotten rid of all the people responsible for inflating the company's oil and gas reserves. I would say that Lukoil looks the cheapest, and probably has more room to grow. However, Russia has an image of a very corrupt country, with memories of the government expropriation and bankrupting of Yukos in the mid 2000's still fresh in many investor's memories. For example, during the 2004 Berkshire meeting, Buffett discussed that he had to decide between buying shares of Yukos or Petrochina (PTR). Ultimately, he purchased shares of Petrochina, because he thought that the risk there was lower. I didn't list Petrochina in the table, but with a P/E of 10.37 and yield of 3.90%, although I would not be surprised if Buffett revisits this trade as well.

Interestingly enough, I sold Exxon in late 2012 and replaced it with ConocoPhillips (COP). I guess COP does not have the scale of Exxon, and does not have any Refining & Marketing operations, which were spun-off in 2012. However, it seems to have a very shareholder friendly management, despite the fact that it doesn't have a lengthy history of dividend increases like Exxon.

As for Chevron, it is one of my largest portfolio positions ( top 3), and I am not sure why Buffett would pick Exxon over it. However, I realize that I am biased on that issue. It could be due to the trial in Ecuador, where Chevron has been ordered to pay billions of dollars in fines for damages. However, I have some doubts about the integrity of the trial against Chevron. Check my analysis of Chevron.

I think Buffett likes the valuation, the economics of the business, and the massive scale of the company. In addition, he likes the high amount of cash flows generated, which allow it to return so much in the form of dividends and share buybacks to shareholders. Furthermore, the company is one of the largest in the world, and therefore, further buying by the Oracle of Omaha is not going to materially impact the stock price. The company is also US based, and therefore all earnings and dividends are not going to be subject to foreign withholding taxes, or add increased uncertainty over foreign governments. Last but not least, the company has proven that it can boost dividends to shareholders, consistently buy back stock, and also effectively deploy cash to replace reserves used. With a shareholder friendly management culture like that, it is no wonder the Oracle of Omaha chose the stock.

Full Disclosure: Long XOM, IBM, WFC, CVX, BP, RDS.B, COP

Relevant Articles:

Check the Complete Article Archive
Dividends versus Share Buybacks/Stock repurchases
Warren Buffett Investing Resource Page
Charles Munger: A Lesson on Elementary, Worldly Wisdom as it Relates to Investment Management and Business
How to Generate Energy Dividends Despite the Peak Oil Non Sense

Saturday, November 16, 2013

Warren Buffett Investing Resource Page

I am a big fan of Warren Buffett, who is the best investor who ever lived. I have studied everything about the Oracle of Omaha that I could get my hands on over the past few years. I also wanted to share the resources I have used to gain knowledge about the investing habits of Warren Buffett. I have organized them into articles I have written about him, books about him, resources such as letters to shareholders, speeches by this super investor, as well as articles from him.

Dividend Growth Investor Articles on Warren Buffett


Books About Warren Buffett

The Snowball: Warren Buffett and the Business of Life

Of Permanent Value: The Story of Warren Buffett/A Trilogy/2010 Edition/Three-volume set

Buffett: The Making of an American Capitalist

Berkshire Hathaway Letters to Shareholders

Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012: A Fortune Magazine Book


Berkshire Hathaway Resources

Berkshire Hathaway Letters to Shareholders since 1977

Buffett Partnership Letters

2013 Berkshire Hathaway Meeting Notes (CSInvesting)

2012 Berkshire Hathaway Meeting Notes (Cove Street Capital)

2011 Berkshire Hathaway Meeting Notes (Innoculated Investor)

2010 Berkshire Hathaway Meeting Notes (Innoculated Investor)

2009 Berkshire Hathaway Meeting Notes (J.V. Bruni & Co)

2008 Berkshire Hathaway Meeting Notes (Max Capital)

2007 Berkshire Hathaway Meeting Notes (Tilson Funds)

2006 Berkshire Hathaway Meeting Notes (Value Investor Insight)

2005 Berkshire Hathaway Meeting Notes (Tilson Funds)

2004 Berkshire Hathaway Meeting Notes (Graham & Doddsville)

2003 Berkshire Hathaway Meeting Notes (Tilson Funds)

2002 Berkshire Hathaway Meeting Notes (Tilson Funds)

2001 Berkshire Hathaway Meeting Notes (Tilson Funds)

2000 Berkshire Hathaway Meeting Notes (The Street)

1999 Berkshire Hathaway Meeting Notes (Motley Fool)

1998 Berkshire Hathaway Meeting Notes (Geocities)

1996 Berkshire Hathaway Meeting Notes ( Burgundy Asset Management)

1994 Berkshire Hathaway Meeting Notes ( Burgundy Asset Management)

Speeches by Warren Buffett

Buffett's Lecture at Notre Dame in 1991 (source)

Buffett's Lecture at the University of Nebraska in 1994

Buffett's Talk with University of Florida Students in 1998

Buffett's Speech at Columbia University in 2002

Lecture with Wharton Students in 2003 and in 2004

Buffett's Lecture with Vanderbilt Students in 2005

The source of those lectures was Tilson Funds.

Monday, October 7, 2013

Price is what you pay, value is what you get

In my dividend investing, I typically try to focus on the big picture. This means that in most cases I tend to ignore short-term fluctuation in stock prices. This is because short-term prices are usually driven by fear and greed, and might be totally out of line with the underlying fundamentals of a business for extended periods of time.

For example, during the global financial crisis, shares of Coca-Cola (KO) fell from a high of $32 in early 2008 to a low of $19 by early 2009. Nothing had changed fundamentally in the business however, as it earned $1.29/share in 2007 and $1.25 in 2008. Not surprisingly, people still wanted to have a few of their favorite drinks, even during a recession. Therefore, the underlying earnings power was still intact for this global franchise, and the company managed to keep increasing earnings to $1.47/share in 2009 all the way up to $1.97/share in 2012.  Investors who focused on the underlying fundamentals of the business, should not have been worried about the stock price declines in 2008 - 2009. The lower prices should actually be viewed as good entry opportunities.

This is why I focus my attention to understanding the fundamentals of the business I am monitoring. In general, I focus on businesses that sell a product or service that has a loyal customer base. As a result, I try to gain confidence in purchasing a business, whose products/services have lower chances of being obsolete in 10 – 20 years. This is very difficult to achieve, because there could be factors that are unknown today and would not be in my thought model, but which could derail my plan completely. For example, few investors would have expected that asbestos is so bad for people in the 1950s. However, it was bad for people, which led to poor performance by asbestos companies and a several bankruptcies in the US for companies in the industry.

However, if you find a collection of stable businesses you understand, which have durable competitive advantages, and you believe they will still be around in 20 years, you can add the shares if they are attractively valued. Monitoring such enterprises would involve reading annual reports, checking the financial figures there, and even quarterly filings to keep track of major developments throughout the year. Tracking every press release or analyst comment on a company you own however might result in information overload, which would actually be detrimental to your investment results. The thing that will make you the most money is rising earnings per share, which is why you need to focus on areas that could aid the company in achieving that.

In other words, I focus on the real earnings power and underlying assets per share of the company I am purchasing. Over time, this piece of information can provide much more value and wealth to me, than watching the stock price oscillate between a high and a low on a given year.

For example, I firmly believe that people would keep brushing their teeth with the brand of toothpaste they have been using in the past. If you monitor the toothpaste aisle on Wal-Mart (WMT), you can see plenty of consumers pulling their carts to the aisle, looking for their desired brand of toothpaste, and then proceeding on to the next item on the list. Since people are creatures of habit, chances are they would stick with a similar brand of toothpaste for years if not decades. People care about their teeth, and brush them even when there is a recession. Companies like Colgate-Palmolive (CL) sell millions of tubes of toothpaste to consumers throughout the highs and lows of the economic cycle. These millions of repeat purchases result in stable revenues and earnings streams for Colgate. The only problem is that the stock has been slightly overvalued in 2013.

The fact that I ignore short term price fluctuations does not mean that I ignore prices all the time. I only focus on them in relation to what I believe the value of a business should be. I usually achieve that by looking at price in relation to normalized earnings, after evaluating the earnings per share trends over the preceding decade. I then look at trends in returns on equity, revenues, dividends, payout ratios in this order. I use all of this information to estimate whether I have a good chance of receiving higher earnings and dividends over the next 20 years. I add all of this information to make a reasonable estimate of whether the value I am receiving is higher than the price of the company.

To paraphrase what famous investor Warren Buffett says “Price is what you pay, value is what you get”. My investment strategy is inspired by the Oracle of Omaha. Hopefully, this post serves to show that in order to be successful, you need to be able to pay a reasonable price for a sound business with attractive future prospects.

Full Disclosure: Long CL, KO, WMT

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Tuesday, August 13, 2013

Has Charlie Munger gone senile on US Energy Independence?

Charlie Munger is the long-term business partner of Warren Buffett, the legendary chairman and CEO of Berkshire Hathaway (BRK.A) (BRK.B). Munger is the deep thinker who has managed an impressive record with his investment partnership, at Wesco Financial and Daily Journal (DJCO). Munger overcame huge obstacles in his life, including death of his son and divorce to make billions of dollars. Munger is the one who changed Buffett’s perspective on business and investing from cigar butt type investments to buying quality companies trading at fair prices. Munger is a genius and has achieved a lot of wealth in the process.

However, sometimes even accomplished people such as Charlie Munger venture outside their level of expertise, and start making statements that sound weird.

I am referring to his comments on energy independence (source: Morgan Housel & this video)

Oil is absolutely certain to become incredibly short in supply and very high priced .. The imported oil is not your enemy, it's your friend. Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you're going to need to feed your people and maintain your civilization. And what responsible people do with a Confucian ethos is suffer now to benefit themselves and their families and their countrymen later. The way to do that is to go very slow in producing domestic oil and not mind at all if we pay prices that look ruinous for foreign oil. It's going to get way worse later ...

The oil in the ground that you're not producing is a national treasure ... It's not at all clear that there's any substitute [for hydrocarbons]. When the hydrocarbons are gone, I don't think the chemists are going to be able to just mix up a vat and create more hydrocarbons. It's conceivable that they could, I suppose, but it's not the way to bet. We should spend no attention to these silly economists and these silly politicians that tell us to become energy independent.

Let me pose a question for you. It's 1930. Oil in the United States is in glut. We have cartels to get the price up to $0.50 a barrel. Everywhere we drill we find more oil in our own country; everywhere we drill in Arabia we find even more.

What would the correct policy of the United States have been in that time? Well, the correct policy would have been to issue $150 billion of very long-term bonds and cart 150 billion barrels of Middle Eastern oil into the United States and throw it into our salt caverns and leave it there untouched until the current age.
It's easy to see that in retrospect, but who do you see who ever points this out? Zero. We have a brain-block on this issue. We should behave now to do on purpose what we did on accident then.”

I read this statement, and I understand his idea in theory. In reality, it seems very stupid. Of course the risk is that maybe i am so simple minded, that i do not understand the wisdom of those words.

First, the size of the US economy was about $100 billion in 1930. So it would have been tough to borrow 150 billion, which would have been 1.5 times the size of economy. I am sure that if this were done in 1930, many people would have been unhappy about this debt deal. It would have also been difficult for a country to sell a debt issue of that size, without shaking the markets and raising its interest rates. The backlash from voters would have been ever worse, as it would have been seen that this is effectively enslaving future generations with interest payments on oil that won’t be used for years. Remember when everyone proclaimed the end of the US as we know it in 2008, when we had the $700 billion in TARP funds? How would you like it if the US government decided to borrow 15 trillion today and buy oil to be used in 100 years?

Second, this idea is nonsense because it introduces the concept of leverage. Leverage is a dangerous tool, that can lead to total destruction of capital even if you are 100% right. A country that instantly leverages itself by borrowing an amount that is 1.50 times the size of its economy is levering itself, and thus leaving it highly susceptible to short term fluctuations in macroeconomic factors. To put it in simple words, things don’t go up or down in a straight fashion. For example, if you were smart enough to recognize the genius of Buffett in 1972, and bought Berkshire Hathaway on margin that very same year, you might have little to show for your forecast. This is because the price of Berkshire stock fell by more than 50% between its 1972 high and 1975 low. An investor on margin would have been forced to sell at the depths of the market crash of 1974, in order to cover margin loans. Munger should have known better, because his friend Rick Guerin did exactly that leveraged experiment, and sold Berkshire at $40/share in 1974.

So back to the thesis on US taking a $150 billion loan to buy oil in 1930. Even if the country somehow managed to convince creditors that it can afford to take this loan, it would have still bankrupted the country. That’s because GDP fell by 40% between 1930 and 1933, and recovered by 1937. GDP in current dollars was 103.6 billion in 1929 and 91.20 billion in 1930. In 1933, GDP was 56.40 billion, and in 1937 it was 91.90 billion. A country with a GDP of 100 billion, that takes 150 billion loan, has a Debt to GDP ratio of 1.50. A country with a GDP of 50 billion and a 150 billion loan has a Debt to GDP ratio of 3.


Source: Shmoop

If this deal that Munger proposes had been done, the US would have been bankrupt by the depths of the Great Depression. Then the oil would have probably had to be sold for pennies on the dollar, simply to repay the debt.

Even if US withstood the harsh realities of great depression, and kept paying off the debt, it would have been much more difficult to raise money to fight Hitler. Between the end of 1940 and the end of 1946, Federal Debt as a percentage of GDP increased from 44.20% to 108.70%. The increase was because money was needed to fight the enemy. Without winning World War II, the US could have either ended up as a communist country or simply ended up as a Fascist country.


Source: Multpl

Further, the oil booms of early 20th century, created a lot of rich people, and developed US economy. The growth in GDP from that, has created a ripple effect that has made all of us richer. This is due to increase in science and technology, and due to providing work for people and lifting them out of poverty.

Munger sounds like a lot of other smart and accomplished people, who say that something cannot be done any more at end of their careers. I am specifically referring to his comment about scientific progress. Let’s go through some examples of successful people making predictions:

Ben Graham said one cannot profitably research stocks anymore in 1976. This was false as his prodigy Buffett proved him wrong, as he was picking GEICO at rock bottom prices. Buffett has also bought shares in Washington Post (WPO), Interpublic (IPG) and other companies at rock bottom prices a few years earlier, after analyzing them.

Munger is saying that science and technology cannot help in discovering oil. First of all, the current US energy revolution is helped by improvements in tech. High oil prices will provide companies with incentives to invent technologies to drill for oil in far reaching places. If prices go higher, i can bet scientists will find that you can make oil and gas in a lab.

Oil is important for energy. But also for other items like plastics, pharmaceutical and other everyday life uses. We can use energy from sun, but not to make plastics. However, chances are that the scientific and technological progress will identify ways to deliver cheap energy and everyday items at low prices some time in the future. Thus, I am not at all worried that oil will run out or that we will go back to living in caves.

Saving all oil so US can use it 100 years later is similar to what Buffett says" like saving sex for old age".

Munger is still investing legend, and I would likely never reach same level of wealth as him. However, he might be best suited to stick to doing investments, rather than discuss macroeconomics. Of course, if your goal in life is to make money in investments, you might not be the best person to make long-term predictions. If Munger is not senile, then his idea could be meaning that oil companies could be good long term investments.

I am happy to be owning Chevron (CVX), ConocoPhillips (COP) and Royal Dutch (RDS.B) ( ranked in order of my happiness holding these companies). The companies yield 3.20%, 4.10% and 5.30% respectively. The moral of this story is that as individual investor, you are the one ultimately responsible for allocating capital. You should not rely 100% on judgement of others. Outsourcing your investment decisions to others could be costly. Also, if you are an investing legend, stick to being an investing legend.

It is also important to learn another thing about risk. As you grow older, you might end up doing decisions that could be very costly. By not being flexible, you can stick to your Citigroup (C) stock in 2008, because it paid you dividends for many years prior to that. This is the reason why I have the automatic rule to sell after a dividend cut. If I have diminished mental capacities in 2040, it would be easier for someone managing my otherwise long-term investments to follow a rule based guideline. I am also considering whether a low risk index fund wouldn't be a good situation, given the lack of interest in managing investments on the part of my descendants. This is something that came to me, as I was thinking about this article. I need to do a little more thinking, and would try to share my findings with you.

Of course, given the long-term nature of my dividend paying holdings, I am fairly confident that a fun-loving DGI trust-fund baby that only collects dividend checks and doesn't sell anything, will likely do well for the next 50 years. My dividend portfolio is built so that it can generate healthy amounts of cash, with low upkeep required.

In summary, I believe that Munger should be sticking to doing investments, rather than solve economic issues. I still find him of the best investment minds of the past 100 years, and plan to keep learning about his investment style.

Full Disclousre: Long CVX, COP, RDS.B

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Wednesday, May 29, 2013

How Warren Buffett built his fortune

Most investors are familiar with Warren Buffet, who is the man in command at Berkshire Hathaway (BRK.B). Buffett is one of the most successful investors of all time, with a net worth placing him somewhere in the top three richest people in the world. His partner in crime was Charlie Munger, who has worked with him for the past 50 years. While most investors are familiar with the story of Berkshire Hathaway, few seem to know how exactly Buffett made his first millions, that catapulted him to Berkshire Hathaway and the companies and stocks he owns through it.

Buffett started several investment partnerships in 1956 with approximately $105,000 in investor money, after his former employer Graham-Newmann investment partnership was liquidated. Buffett had put an initial $700 of his own money, which ballooned to a stake worth $20 million by the time he liquidated his investment partnership in 1969. The assets under managed had grown to $100 million by that time. The Berkshire Hathaway (BRK.A) annual letters to investors have been inspired by Buffett’s annual and semi-annual letters to his limited partners.

Per the Buffett Partners agreement, Buffett as the General Partner received a cut of the profits. For every percentage point gain above 6% in a given year, Buffett collected 25% of the gains. The Buffett Partnership Limited (BPL) was essentially a hedge fund, which pooled investor’s money and invested them at the discretion of the fund manager. Buffett never had a losing year during the thirteen years he ran the partnership, and he also managed to add new investors along the way. In addition, he reinvested any gains he made as a general partner back into the partnership.

Buffett invested in the following types of companies at the partnership: generally undervalued securities, work-outs and control situations. Work-outs included stocks whose financial results depend on corporate actions rather than supply and demand factors created by buyers and sellers. Control situations include occasions where BPL either controlled the company or took a sufficiently large position that allowed it to influence policies of the company.

After the BPL was liquidated, Buffett received shares in Berkshire Hathaway, as well as shares in companies which ultimately merged in Berkshire. And the rest is history.

The lesson to be learned from this exercise is that in order to become rich, Warren Buffett had a scalable business model, with a substantial amount of leverage. Unfortunately, BPL was mostly a one-man operation, although the turnaround expert he employed with Dempster Mill Manufacturing company is a rare situation where he employed others. He did exchange ideas with several of his value investing friends however. Buffett’s investment model worked well when he had $100,000 in the partnership, as well as during the time that he had $100 million. The overvalued market in the late 1960’s however presented a change to his investment strategy. Buffett had leverage to make a lot of money, simply by being the general partner and earning a good cut on any earnings that the partnership generated, without much downside for himself. On the other hand, Charlie Munger made his initial million by using debt leverage to invest and build real estate.

The true genius of Buffett is his complete transformation in the 1970’s, when he started purchasing stock in companies with strong competitive advantages. He essentially held those stocks as long-term investments, and in the event where Berkshire acquired entire businesses, he delegated the whole oversight of day to day operations to skilled management. The companies he invested in the 1950’s and 1960’s represented mostly investments that were one-time producers of substantial gains for BPL. It took Buffett a lot of time to uncover those opportunities, but once they reached full valuation and he sold them, they were no longer producing any benefit for his partnership. He then had to spend more time to find more investments to allocate the now higher cash hoard. However, the companies and securities that Buffett purchased since the 1970’s for Berkshire Hathaway generate recurring cash flow streams to the company. As a result, the effort required to uncover these hidden gems resulted in cash distributions paid to the main holding company for decades. He then used these cash streams to purchase even more cash flow generating assets, which is why I believe that he is a closet dividend investor.

Buffett's operations at Berkshire were further aided by almost cost-free float from insurance operations, which further magnified his investment returns. The float refers to the time period between when premiums are collected and claims paid out. During this time, insurers invest the premiums and generate returns. Buffett only does insurance deals when the pricing is right, and can guarantee that it doesn't result in losses The float further magnified investment returns, therefore leveraging Buffett's investment genius to produce gains for shareholders. For example, if you purchased Coca-Cola at $20 and it doubled in price, you can earn 100% return on your investment. If you put $20 of your money in the stock and invested $20 of cost free float, you would have earned a 200% return on that investment.

The genius of Buffett is that he has been able to uncover undervalued assets, over many different asset classes. Examples include his purchase of silver (SLV) in 1998, real estate investment trusts in 1999, foreign currencies such as the Euro in the early 2000's as well as selling long-dated puts on major market indices. While he has a strategy of always looking for undervalued assets, he has been able to make a fortune for Berkshire by being flexible, and avoiding following a "rigid" strategy. By training himself to spot opportunities when they arose, he has been able to constantly reinvent himself and make money in different environments.

Full Disclosure: None

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This article was included in the Carnival of Wealth

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