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

Buffett Nebraska

Q What exactly do you do all day?
A I spend an inordinate time reading. I probably read atleast six hours a day, maybe more.And I spend an hour or two on the telephone.And I think. Thats about it.

-I would say there is no hunch or intuitiveness or nothing of the sort. I try to sit and figure out what the future economic prospects of a business are. I try to figure out whether the management is someone or a group I both trust and admire, and I try to figure out whether the price is right. I mean that: Its the right business, the right people and the right price.

Buffett notredame, pricing power

Buffett Notredame

-I would say that the most important thing in business, and investments, which I regard as the same thing, from our standpoint, is being able to accurately define your circle of competence.

-You need very few good ideas in your lifetime. You have to be willing to have the discipline to say, “I’m not going to do something I don’t understand.”

-Why should I do something I don’t understand? That’s why I find it an advantage to be in Omaha instead of New York. I worked in New York for a few years, and people were coming up to me on the corner and whispering in my ear all the time. I was getting excited all the time. I was a wonderful customer for the brokers.

-But now you say “I don’t know how to evaluate the Washington Post.” It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what? You can’t [invest safely with such a small margin of safety]. If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that.

-[Question from audience about how many of his investment ideas are pitched to him by others.]

Practically none. The Wall Street Journal is my deal source. There are 1,700 or 1,800 of America’s companies that I’m generally familiar with

-We read hundreds and hundreds of annual reports every year. I own 100 shares of everything. I find this much more reliable than asking to be put on a mailing list

-Well, I would say this. If we were working with $25 million – so we could sort of look at the whole universe of stocks – I would guess that you could find 15 or 20 out of three or four thousand that you would find that were A) selling for substantially less than they’re worth, and B) that the intrinsic value of the business was going to grow at a compound rate which was very satisfactory.

-You don’t want to buy a dollar bill that’s sitting for 50 cents, and it demands positive capital, and it’s going to be a dollar bill ten years from now. You want a dollar bill that’s going to compound at 12% for [a long time].

-Incidentally, I would say that almost everybody I know in Wall Street has had as many good ideas as I have, they just had a lot of [bad] ideas too. And I’m serious about that. I mean when I bought Western Insurance Security selling at $16 and earning $20 per share, I put half my net worth into it. I checked it out first – I went down to the insurance commission and got out the convention statements, I read Best’s, and I did a lot of things first.

-A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the mirror and say “mirror, mirror on the wall, how much should I charge for Coke this fall?” [And the mirror replies, “More.”] That’s a great business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] “just another half cent a yard.” Then you get up and they say “We won’t pay it.” It’s just night and day. I mean, if you walk into a drugstore, and you say “I’d like a Hershey bar” and the man says “I don’t have any Hershey bars, but I’ve got this unmarked chocolate bar, and it’s a nickel cheaper than a Hershey bar” you just go across the street and buy a Hershey bar. That is a good business.

-I’ll try this on the students later: What’s the highest price of a daily newspaper in the United States? [Pause] The highest priced daily newspaper in the United States is the Daily Racing Form. 150,000 copies a day, $2.25 a copy, they go up in 25 cent intervals, and it doesn’t affect circulation at all. Why? There is no substitute. If you go to the track, assuming you’re a forms player, you don’t want “Joe’s Little Green Sheet”, you want The Form. And it doesn’t make any difference what it costs! There is no substitute. And that’s why they’ve got a 65% pretax margin. It doesn’t take a genius to figure it out.
There are products like that, and there are products like sheet steel. And they’re night and day.

-Then [I said] “I’ve got only one other question: How do you figure out how much to charge people? You look like a man of awesome commercial instincts – you started with a $1,500 radio station, now you’re worth $4 or $5 billion dollars.”
He said “Well, that’s another good question. I just tell my US managers to try and make 45% pretax and figure that’s not gouging.”

-Lord Thompson, once he bought the paper in Council Bluffs, never put another dime in. They just mailed money every year.

- The idea was that, essentially, he raised prices and raised earnings there every year without having to put more capital into the business.

-The product was undifferentiated (berkshire lining). The candy product is differentiated (sees). (Garbled story of Hershey Bar and Coke versus unbranded but modestly cheaper products).

-You really want something where, if they don’t have it in stock, you want to go across the street to get it. Nobody cares what kind of steel goes into a car.

-someday, there’s going to be some business I understand selling for way less than the value I arrived at. It doesn’t have anything to do with book value, although it does have to do with earnings power over a period of time. It usually relates, fairly closely, to cash [flow]

-Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street.

-Western Insurance companies: I didn’t have any background in insurance. But I knew I could understand it if I worked at it for a while. And all I was really trying to do was disprove this thing. I was really trying to figure out something that was wrong with this. Only there wasn’t anything wrong. It was a perfectly good insurance company, a better than average underwriter, and you could buy it at one times earnings.

-think the Wall Street Journal is essential. I spend 45 minutes a day with the Wall Street Journal. Actually, I got up the night before, about 11:00... I frequently read it at night. But I’ll read anything. Actually, I probably spend five or six hours a day on reading

-Buried in rented suit

Mecham

Mecham:

-It’s really quite simple. I need to understand the business like anowner. The firm needs to have staying power; I want to be confident about thegeneral nature of the business and industry landscape on a longer term basis 

-In fact, I think very little about quarterly earnings and more aboutthe barriers to entry, competitive landscape/threats, the ongoing capital needsand overall economics, and most importantly, the durability of the business 

-Wealso stress test the business under various economic scenarios and look to anormalized earnings power. We passed up many seemingly attractive ideas overthe years as we would ask, “What happens under 7-10% unemployment (whenunemployment was in the 4-5% range) and 6-8% interest rates?

 
-“Is the business overly reliant on loose credit extension and frivolousspending?” Many names didn’t hold up under these stress test scenarios, so wepassed.

 
-We prefer cockroach-like businesses — very hardyand almost impossible to kill!

 
-Oftentimes a key cog of valueis in a form that’s difficult to measure — brands, mindshare/loyal customers,exclusive distribution rights, locations, management, etc. Sometimes it’s thelocation of assets that can be hugely valuable. Waste Management [WM] andUSG [USG] both have assets that are uniquely located and almost impossible toduplicate, which provides a low-cost advantage in certain geographies.

 
-Any time you arepaying a price today that’s dependent on heroics tomorrow — fantastic growthfar into the future, favorable macro environment, R&D breakthroughs, patentapproval, synergies/restructurings, dramatic margin improvements, large payofffrom capex, etc. — you run the risk of inviting pesky over-optimism(psychologists have shown overconfidence tends to infect most of us), whichcan result in skewed probabilities and payoffs. We want to see a return todayand not base our thesis on optimistic projections about the future. Investments based on projections that are disconnected from any historicalrecord make us leery. Investments dependent upon a continued frothy macroenvironment (housing, loose credit) are prone to over-optimism as well — howmany housing-related/consumer credit companies were trading at 6x multiplesgrowing 15%+ inviting IV estimates 5x the current quote?

-How do you generate investment ideas?

Mecham: Mainly by reading a lot. I don’t have a scientific model to generateideas. I’m weary of most screens. The one screen I’ve done in the past was bymarket cap, then I started alphabetically. Companies and industries that are outof favor tend to attract my interest. Over the past 13+ years, I’ve built up a baseof companies that I understand well and would like to own at the right price. Wetend to stay within this small circle of companies, owning the same namesmultiple times

-That’s the beauty of the public markets: If you can be patient, there’s a goodchance the volatility of the marketplace will give you the chance to owncompanies on your watch list. The average stock price fluctuates by roughly80% annually (when comparing 52-week high to 52-week low). Certainly, theunderlying value of a business doesn’t fluctuate that much on an annual basis, sothe public markets are a fantastic arena to buy businesses if you can sit stillwithout growing tired of sitting still

-We try andstick with companies we understand, where we have a high degree of confidencein the staying power of the firm. We spend considerable effort thinking criticallyabout competitive threats (Porter’s five forces, etc). We really stress long-termstaying power and management teams with proven track records that are focusedon building long-term value. Then we always “stress test” the thesis againstdifficult economic environments.

 

-If the financialcrisis taught nothing else, it showed how elegant financial models that calculaterisk to decimal point precision act like a sedative towards critical thinking andeven common sense

 
-Most investors are their own worst enemies — buying and sellingtoo often, ignoring the boundaries of their mental horsepower. I think ifinvestors adopted an ethos of not fooling themselves, and focused on reducingunforced errors as opposed to hitting the next home run, returns would improvedramatically

 

  

 

When to walk away

Scott doesn’t need predictions of US$60 iron ore to tell him to steer clear of the notoriously cyclical sector. If he can’t reasonably predict the future demand or supply for something — especially a commodity like iron ore — he simply walks away.

There are no penalties in the investing game for missing out on the next big winner.

From http://www.forbes.com/sites/johnnosta/2013/02/25/the-genius-of-raising-brilliant-kids/

Limit rules, encourage independence.  We have ‘minimal rules’, but nothing that stifles creativity. Basically, you can sum it up simply: treat people with respect, do your homework be honest and try to be safe.  Having too many rules burdens down the entire family and limits thinking.