WB criteria for valuation of the market and some quotes

From a Motley Fool article :

In 2001 Buffett explained that determining whether the market is expensive or cheap doesn't have to be complicated. Here's the metric he uses:

The market value of all publicly traded securities as a percentage of the country's business -- that is, as a percentage of GNP. Basically, Buffett divides the total market capitalization of the U.S. stock market by gross national product. GNP measures the value of goods and services that a country's citizens produce regardless of where they live. This includes the value of goods and services that American companies produce abroad.

Buffett : "If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200% -- as it did in 1999 and a part of 2000 -- you are playing with fire."

The most common way to calculate the market value is by looking up the market capitalization of the Wilshire 5000. The market cap of the Wilshire 5000 was $20.6 trillion. The Federal Reserve Bank of St. Louis has a great website where you can locate GNP ($16.9 trillion). (http://research.stlouisfed.org/fred2/series/GNP/)

Dividing the total market cap by GNP gives 122% indicates that the market is getting pricey.


-We don't spend any time looking back. We figure there is so much to look forward to, there's just no sense thinking of what might have been, it just doesn't make any difference. You can only live life forward. You can perhaps learn something from the mistakes

-Interest rate impact. What you really want to know in investments is what is important and what is knowable. If its unimportant or unknowable, you forget about it. We don't want to pass up a chance to do something intelligent because of some prediction that we're no good on anyway. So we don't read, or listen or do anything based on macro factors, zero.

-Concentrate on what will happen, not on the when. The when is unknowable.

Good checklist for investing

There's a good compilation of questiosn to think of before investing.

The Quality Of Business Earnings - Checklist Of Questions

by Tannor Pilatzke


Here are quotes by WB from here :

“Investing is reporting. I told him to imagine an in-depth article about his own paper. He’d ask a lot of questions and dig up a lot of facts. He’d know The Washington Post. And that’s all there is to it.”

“You need a moat in business to protect you from the guy who is going to come along and offer it (your product) for a penny cheaper.”

“If (you go into a store and) they say ‘I don’t have a Hershey bar, but I have this unmarked chocolate bar that the owner of the place recommends,’ if you’ll walk across the street to buy a Hershey bar or if you’ll pay a nickel more for the (Hershey) bar than the unmarked bar or something like that, that’s franchise value.”



“How much more fruitful it is for us to think about whether the product is likely to sustain itself and its economics than to try to be questioning whether to jump in and out of the stock.”

“If I’m thinking about investing in a specific company, I try to size up their business and the people running it. And as I read annual reports, I’m trying to understand generally what’s going on in all kinds of businesses. If we own stock in one company and there are eight others in the industry, I want to be on the mailing list for the annual reports of the other eight because I can’t understand how my company is doing unless I understand what the other eight are doing. I want perspective on market share, margins, the trend in margins – all kinds of things...”

“It’s amazing how well you can do in investing with what I’d call “outside” information. I’m not sure how useful inside information is. But there’s all kinds of “outside” information around as to businesses. And you don’t have to understand all of them. You just have to understand the ones you’re thinking about investing in. And you can. But no one can do it for you.”

“In my view, you can’t read Wall Street reports and get anything out of them. You’ve got to get your arms around it yourself. I don’t think we’ve ever gotten an idea from a Wall Street report. However, we’ve gotten a lot of ideas from annual reports. Charlie?”


“PUCCI”: Pricing, Units, Costs, Competition and Insiders



“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.” -- Warren Buffett

For the casual investor, Greenblatt recommends buying a portfolio of 20-30 Magic Formula stocks, holding for one year, and then re-running the process annually.

On the interest rate environment

The 'Rate Gap' Is Rising (http://online.wsj.com/news/articles/SB10001424052702304384104579143450479627172?mod=djemITP_h)
The gap between deposit rates and borrowing rates is higher than it's been in 32 of the last 40 years. by Andrea Coombes


Low interest rates have been bruising savers for years, but for a while those same low rates
were proving a boon to mortgage borrowers.

Not anymore.

In fact, the gap between the interest consumers earn on a savings account and the rate they pay on a 30-year fixed-rate mortgage is its widest in two years—and among the highest in more than 40 years—according to data analyzed by MoneyRates.com.

The widening spread also is a sign of the hurdles faced by retirees and other savers who are trying to generate income from relatively conservative investments.


For the month of September, the spread between the average rate on a 30-year fixed-rate mortgage (4.49%) and the average rate on a one-month certificate of deposit (0.06%) was 4.43 percentage points, according to data from the Federal Reserve and Federal Deposit Insurance Corp.


Since 1971, the average gap between those rates has been 2.83 percentage points. In 2007, the gap hovered around one point.

The gap has been higher than average since November 2008, shortly after the onset of the financial crisis, coinciding with efforts by the Fed to push short-term rates lower to stimulate the economy. Then the difference shrank to less than four percentage points for most of the past two years.


The problem for savers is that rates on savings accounts, money-market funds and certificates of deposit are tied very closely to short-term interest rates. But other interest rates are subject to a variety of market forces that tend to drive those rates higher, including lenders' perception of risk from inflation and default.


"If you're a bank and you're going to make a 30-year commitment, you don't want to be caught receiving a substandard interest rate," says Richard Barrington, a senior financial analyst at MoneyRates.com. "You're going to be pretty quick to raise your rates on any hint that mortgage rates might be due to go up."


The highest gap recorded since 1971 between 30-year fixed-rate mortgages and one-month CDs was 6.2 percentage points in August 1982. But back then, a one-month CD paid more than 10%. Today, by comparison, "the income-producing ability of your savings has virtually disappeared," Mr. Barrington says.

Consumers have a few options. Consider owning only shorter-term CDs, so you don't lock yourself into meager payments for the long run. Look into online savings accounts, which have fewer restrictions than CDs yet may pay the same or better rates right now. And consider shorter-term mortgages, since they tend to have lower interest rates than 30-year loans do.

From http://on.wsj.com/15ApOsp    Why Tough Teachers Get Good Results

Psychologist K. Anders Ericsson gained fame for his research showing that true expertise requires about 10,000 hours of practice, a notion popularized by Malcolm Gladwell in his book "Outliers." 

The rap on traditional education is that it kills children's' creativity. But Temple University psychology professor Robert W. Weisberg's research suggests just the opposite. Prof. Weisberg has studied creative geniuses including Thomas Edison, Frank Lloyd Wright and Picasso—and has concluded that there is no such thing as a born genius. Most creative giants work ferociously hard and, through a series of incremental steps, achieve things that appear (to the outside world) like epiphanies and breakthroughs.

Prof. Weisberg analyzed Picasso's 1937 masterpiece Guernica, for instance, which was painted after the Spanish city was bombed by the Germans. The painting is considered a fresh and original concept, but Prof. Weisberg found instead that it was closely related to several of Picasso's earlier works and drew upon his study of paintings by Goya and then-prevalent Communist Party imagery. The bottom line is that creativity goes back in many ways to the basics. "You have to immerse yourself in a discipline before you create in that discipline."

http://online.wsj.com/article/SB10001424127887324324404579044891534700108.html

Many money managers spend their days in meetings, riffling through emails, staring at stock-quote machines with financial television flickering in the background, while they obsess about beating the market. Mr. Munger and Mr. Buffett, on the other hand, "sit in a quiet room and read and think and talk to people on the phone," says Shane Parrish, a money manager who editsFarnam Street, a compelling blog about decision making.

We're happy due to: a strong sense of purpose, meaningful work, good friends, health, loving relationships, chance to learn, grow and help others. Long term profits come from having a deeper purpose, great products, satisfied customers, happy employees, great suppliers, and from taking responsibility for the community and environment.
John Mackey (Investment checklist)

You can't make a good deal with a bad person.
Turnarounds seldom turn.

“If you don’t know jewelry, know the jeweller.”

You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.

If a business does well, the stock eventually follows.

There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do.


I am out of step with present conditions. When the game is no longer played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, and so on. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand ( although I find it difficult to apply ) even though it may mean foregoing large, and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully, and which possibly could lead to substantial permanent loss of capital. - 1969

If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that. “Homespun Wisdom from the ‘Oracle of Omaha’", BusinessWeek, 5 July 1999.


No sector is a good buy unless you understand the business. However, I do believe that there is good value and great opportunity now in the financial sector because it is extremely unpopular. Sector’s themselves don’t make good buys, companies that are undervalued make good buys. You know how to value a business, you project the future cash flows discounted to present and buy with a margin of safety. The earnings prospects need to be greater than the current value. Anything that is unpopular is always great to look at. If I was getting out of school right now, I would take a look.

None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy.


-WB

From PD James "The private patient"

-His life was a mess. Some part of his nature, timid, indolent, lacking in confidence, had led him into this pattern of indecision, of leaving things to sort themselves out, as if he put faith in a benevlovent providence which would operate on his behalf if left alone.

-You surely understand one thing, the need to do what every instinct of your body tells you is ordained for you.

-Don't we all at some time or another make a decision which we know is absolutely right, the assurance that some enterprise, some change, is imperative? And even if it fails, to resist it will be a greater failure. I suppose some people would see that as a call from God.

-Life is too precious and too short to waste on people we don't care for, and much to precious to give up on love.

-A garden she could make and cherish, a useful job that she could do without strain with people she respected...

-"I like you, I respect and admire you. I'm never bored on irritated when we're together, and we share the same passion for the house, and when I return here and you're not about I feel an unease which is difficult to explain. Its a sense that there's something lacking, something missing. Can you call that love? Is it enough? It is for me, is it for you? Do you want time to think about it ?" And now she turned to him, "Asking for time would be play-acting. It is enough".

From "http://www.businessnewsdaily.com/4211-business-profile-warren-buffett.html"

"You can have the greatest goals in the world," he said, "but if you have the wrong people running it, it isn’t going to work. On the other hand, if you’ve got the right person running it, almost anything is possible."

-When his first child was born, he turned a dresser drawer into the baby's bassinet and borrowed a crib for the second child. Not one for fancy cars, Buffett drove a Volkswagen until his wife upgraded him to a Lincoln Towncar. 

-"I'm happy there," he said. "I'd move if I thought I'd be happier someplace else. How would I improve my life by having 10 houses around the globe? I'm warm in the winter; I'm cool in the summer. It's convenient for me."

-"I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will."

Avoiding mistakes - routine is key

Having well-defined procedures is a start. For everything from acquisitions to annual budgets, when CFOs and management teams follow well-structured processes, more careful analysis takes place. Checks and balances kick in that can curb impulses and other destructive forms of fast thinking.

Aswath Mohan on Valuation

-Some analysts determine operational cash to be 1-2% of revenues. Rest is treated as excess cash and used to reduce debt balance.

-It is safer to separate cash and marketable securities from operating assets and to value them individually.  Thisis because we use operating income to estimate free cash flows to the firm and operating income generally does not include income fromfinancial assets. Once you value the operating assets, you can add the value of the cash and marketable securities to it to arrive at firm value.

From Seth Klarman's 2007 MIT speech

-A steadily rising housing market erased fears of credit risk, since one’s credit really doesn’t matter if the collateral—in this case houses—is only going up in value 

-Institutional selling of a low-priced small-capitalization spinoff, for example, can cause a temporary supply-demand imbalance. If a company fails to declare an expected dividend, institutions restricted to owning dividend-paying stocks may unload shares. Bond funds allowed to own only investment-grade debt would dump their holdings of an issue immediately after it was downgraded below BBB by the rating agencies. Market inefficiencies, like tax selling and window dressing, also create mindless selling, as can the deletion of a stock from an index. 

-My firm’s approach is to seek situations where there is urgent, panicked or mindless selling.

-smart investors look to the market not as a guide for what to do but as a creator of opportunity.

-The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk

Case Schiller P/E 

Diversification reduces risk

If there is a bet on a flip of a coin : $100 becomes $120  on heads and becomes 0 on tails.
Value of bet is : 120 *0.5 + (-100) * 0.5 = 10.
Return is 10/100 but worst case is too risky (-100%)

If there are 10 coins, $10 bet on each, it becomes : $12 on each head and $0 on tails.
value of bet is 5heads and 5 tails : 10* (12 * 0.5 + (-10) * 0.5) = 10   = 10%
If it is 4H:6T : 4*(12 * 0.5) + 6*(-10)*0.5 = 24 -30 = -6  = -6%


-Lastly, O’Shaughnessy believes that proper diversification is a key factor in maintaining a profitable portfolio. He recommends at least 25 stocks in a micro-, small- or mid-cap portfolio and at least 10 in a large-cap portfolio. 
-In case you were wondering, a strategy based on buying stocks with the worst 6-month returns and then holding for a year had an annualized return of 4.15 percent (compared to 14% for low p/s)!  As stated in the book, “If you’re looking for a great way to underperform the market, look no further [than buying relative strength laggards].”
-Low P/S and P/B led to best returns.  Adding a generic relative strength strategy based on a 6-month return factor with annual rebalances outperformed further.

Greenblatt's little book notes

From Greenblatts little book that beats the markets
-If the gum shop earns 1.2M last year. 1M shares. How much  to buy at?  $12 seems good for 10% earnings yield. But main problem in investing is determining if we will get $1.2 per year going forward as well and if earnings could be higher going forward.

-There are many ways to define what makes a business good or bad- quality of products or services, loyalty of customers, value of its brands, efficiency of its operations, strength of competitors, long term prospects of a business.

-If it cost jason $400K to build each of his gum stores and if each store earned him $200K, he is earning a retun on capital of 50%.

-Buy at high earnings yield + high ROIC

-Graham suggested that by buying a group of these bargain stocks, investors could safely earn a high return without worrying about a few bad purchases and without doing complicated analysis of individual stocks.

-Magic Formula : IT takes also stocks and ranks them based on earnings yield. It also takes the same list and ranks them on ROIC. Then the two ranks are added together for a final list that is ranked from highest to lowest combined score.

From "The outsiders" by William Thorndike

-The outsider CEOs achieved extraordinary results by consistently zigging while their peers zagged.

-The outsider CEOs consistently calculated the projected return before starting a project. They believed that the value of the financial projections was determined by the quality of their assumptions, not by the number of pages. Many developed single-page analytical templates that focused employees on key variables. These deceptively simple but analytical one-pagers served as a trigger to invoke Kahneman's slower reflective/analytical System 2

-To Buffett, there is a compelling  Zen-like logic in choosing to associated with the best and in avoiding unnecessary change.

-Buffett believes that excellent investment ideas are rare and exceptional returns come from concentrated portfolios. "We believe that a policy of portfolio concentration may well decrease risk if it raises the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it"
-Better to change vessels in a chronically leaking boat than to patch leaks

-See's : The Turning point : WB bought See's for $25 million. They had tangible book of $7M and 4.2M in pre-tax profits. They paid an exorbitant 3X book and 6 times pre-tax income compared to Graham's strictures. They saw a beloved brand with excellent returns on capital and untapped pricing power. The company has sent 1.65B in free cash to Omaha in 39 years.

-Buffett's contrarian insight was that companies with low capital needs and the ability to raise prices were actually best positioned to resist inflation's corrosive effects.

-The deals not done were very important.

-Singleton was a very disciplined buyer, never paying more than 12 times earnings and purchasing most companies at lower multiples. Many companies were acquired using Teledyne's pricey stock.

on gold

From Hulbert on gold 3/29/13

Consider: Investors who bought gold at its January 1980 peak of $875/oz are today still below water in inflation-adjusted terms. They even were showing a loss two years ago when gold was trading for more than $1,900.

The investment implication is to pay careful attention to gold's longer-term cycles before buying gold—or be willing to hold it for many decades.

So how should you decide where gold is in its long-term cycle? As a rule of thumb, the researchers urge investors to calculate a ratio of gold's price to the level of the consumer-price index. This ratio's historical average has been about 3.4 to 1, so it is a good bet that gold is overvalued whenever the ratio is well above that level.

When gold hit its high over $1,900 an ounce in September 2011, for example, the ratio was more than 8 to 1. In January 1980, the ratio stood at more than 11 to 1.

Unfortunately for the gold bugs, the current gold/CPI ratio—5.3 to 1—is still above average, even in the wake of gold's plunge over the past three months. To be in line with that average, gold would have to trade for $780 an ounce. 

buffett 2013 AM

http://dealbook.nytimes.com/2013/05/04/live-blog-berkshire-hathaways-2013-shareholder-meeting/


Q Asked about Herbalife and Ackman's fight and multi-level marketing.
A Mr. Buffett replies that the ultimate test is whether there’s a market for the goods being sold. And in the case of Pampered Chef, he says, there’s no question that there is. (BH owns Pampered Chef, also an MLM)

Qut still, interest rates will rise, and it will be a “shot heard around the world.”

A separate question from Ms. Quick: How does the policy affect Berkshire’s companies? Mr. Buffett notes how asset prices have risen because of the abundance of cheap debt, as well as lowering the costs for a deal like the Heinz takeover.

“This is like watching a good movie, as far as I’m concerned,” he says, “because I don’t know how it will end.”

Mr. Buffett says that the past decade has generally been rough for business. That said, if the market continues to rally as it has this year, Berkshire will suffer its first five-year period of trailing the S.&P. 500.

“It won’t be a happy day, but it won’t discourage us,” he said. He added as a caveat that the company is likely to outperform the market in down years.

• What Buffett says about his research and process in making investments given there are legendary stories of his past due diligence, including of American Express, where he hired advisers. That contrasts to the $5 billion he put into Bank of America in 2011, which Buffett has admitted he decided in the bathtub would be a good idea and called.
• “You have to love something to do well at it. ... It is an enormous advantage if you absolutely love what you are doing. ... The nature of it is that intensity adds to your productivity.

  That follow-up shareholder asked them about metrics and screening for stocks, and Buffett and Munger both said they don’t really look at numbers.
• “We are looking at businesses exactly like we are looking at them if somebody came in and asked us to buy the whole business,” Buffett said. He said they then want to know how it will do in ten years.

  Munger was even more forceful: “We don’t know how to buy stocks by metrics ... We know that Burlington Northern will have a competitive advantage in years ... we don’t know what the heck Apple will have. ... You really have to understand the company and its competitive positions. ... That’s not disclosed by the math.

  Buffett: "I don’t know how I would manage money if I had to do it just on the numbers"

  Munger, interupting, "You’d do it badly."

WB U nebraska speech contd

We pay no attention to economic forecasts. I don’t read anything [along those lines]. I read annual reports, but I don’t read anybody’s opinion about what’s going to happen next week, or next month or next year.

The second question is whether there are any special industries we favor. The only thing we favor is industries we can understand. And then, we like businesses with what I call “moats” around them. We like businesses that are protected in some way from competition. If you go in the drugstore and say “I want to buy a Hershey bar” and the guy says “I’ve got an unmarked chocolate bar that’s a nickel cheaper,” you’ll buy the Hershey bar or you’ll go across the street.

One of the interesting things to do is walk through a supermarket sometime and think about who’s got pricing power, and who’s got a franchise, and who doesn’t. If you go buy Oreo cookies, and I’m going to take home Oreo cookies or something that looks like Oreo cookies for the kids, or your spouse, or whomever, you’ll buy the Oreo cookies. If the other is three cents a package cheaper, you’ll still buy the Oreo cookies. You’ll buy Jello instead of some other. You’ll buy Kool Aid instead of Wyler’s powdered soft drink. But, if you go to buy milk, it doesn’t make any difference whether its Borden’s, or Sealtest, or whatever. And you will not pay a premium to buy one milk over another. You will not pay a premium to buy one [brand of] frozen peas over another, probably. It’s the difference between having a wonderful business and not a wonderful business. The milk business is not a good business.

Anything that differentiates your product – those are the businesses we like to be in.

The durability and strength of the franchise is the most important thing in figuring out [whether it’s a good business]. If you think a business is going to be around 10 or 20 years from now, and that they’re going to be able to price advantageously, that’s going to be a good business. And if somebody has to have a prayer session every time they want to raise the price a dollar a pound on whatever they’re selling, that’s not going to be a good business.

One of the things you will find, which is interesting and people don’t think of it enough, with most businesses and with most individuals, life tends to snap you at your weakest link.

The two biggest weak links in my experience: I’ve seen more people fail because of liquor and leverage