Tag Archives: ideas

Comments On Mistakes And Buffett’s Original Berkshire Purchase

I was reading through the 2014 (last year’s) Berkshire Hathaway ( BRK.A , BRK.B ) annual report and 10-K, looking for a few things, and happened to reread Buffett’s letter from last year. I wrote a post a couple weeks ago concerning buybacks and Outerwall (NASDAQ: OUTR ), and how a company that is buying back stock of a dying business is not a good use of capital. I noticed a passage in last year’s letter that is relevant to the topic – Buffett himself was attracted to buybacks on a dying business, Berkshire Hathaway, in the early 1960s. Berkshire was a Ben Graham cigar butt – it was trading at around $7, and had net working capital of $10 and book value of $20. It was a classic “net net” – a stock trading for less than the value of its cash, receivables, and inventory less all liabilities. Buffett liked the fact that Berkshire was (a) trading at a cheap price relative to liquidation value, and (b) using proceeds from the sale of plants to buy back shares – effectively liquidating the company through share repurchases. Here is what Buffett was looking at when he originally bought shares in this company in the early 1960s: Like Outerwall, Berkshire’s business was in secular decline. In fact, it had been dying a long time, as the meeting notes from a 1954 Berkshire board meeting stated: “The textile industry in New England started going out of business forty years ago”. Also like Outerwall, Berkshire was buying back stock. One difference (among many, of course) between Berkshire then and Outerwall now is that Berkshire was closing plants and using proceeds to buy back shares. From the 1964 Berkshire report (which can be found on page 130): “Our policy of closing plants which could not be operated profitabily was continued, and, as a result, the Berkshire King Philip Plants A and E in Fall River, Mass. were permanently closed during the year. The land and buildings of Plant A have been sold and those of Pant E offered for sale… Berkshire Hathaway has maintained its strong financial positiona nd it would seem constructive to authorize the Directors, at their discretion, to purchase additional shares for retirement.” Outerwall, on the other hand, is producing huge amounts of cash flow from its operations, not from the sale of fixed assets. Liquidation versus Leveraged Buyout Another difference is that Berkshire was in liquidation mode, and was buying out shareholders (through buybacks and tender offers) from cash proceeds it received from selling off plants. Outerwall hasn’t been liquidating itself through buybacks-instead it has leveraged the balance sheet by issuing large amounts of debt, using the proceeds to buy back stock, which has reduced the share count, but not the size of the balance sheet or the amount of capital employed. Outerwall had total assets of around $1.3 billion five years ago, roughly the same as it does now (goodwill, however, has doubled due to acquisitions). These assets were financed in part by $400 million of debt and $400 million of equity in 2010. Today, the company’s assets are financed by roughly $900 million of debt, and shareholder equity is now negative. Outerwall has historically produced high returns on capital, and it’s a business that doesn’t need much tangible capital to produce huge amounts of cash flow (an attractive business), but has been run similar to companies that get purchased by private equity firms – leverage up the balance sheet, issue a dividend (or buy out some shareholders), thus keeping very little equity “at risk”. It’s a gamble with other people’s money, and sometimes it results in a home run (sometimes, of course, it doesn’t). So, Berkshire in the 1960s was more of a slow liquidation. Outerwall is basically a publicly traded leveraged buyout. In the case of BRK, shareholders who purchased at $7 were rewarded with a tender offer of just over $11 a few years later. But that’s the nature of cigar butt investing – sometimes at the right price, there is a puff or two left that allows you to reap an outstanding IRR on your investment. In Buffett’s case, had he taken the tender offer from Seabury Stanton, his IRR on the BRK cigar butt investment would have been around 40%. He didn’t, though, and the rest is history. It’s interesting to note another mistake that he points out in last year’s letter – one that I think is rarely mentioned, but was very costly. Instead of putting National Indemnity in his partnership, which would have meant it was 100% owned by Buffett and his partners, he put it into Berkshire Hathaway, which meant that he and his partners only got 61% interest in it (the size of the stake that Buffett had in BRK at the time). I think this could have been Buffett’s way of doubling down on Berkshire (then, a dying business with terrible returns on capital). He thought he could save it (not the textile mills, but the entity itself) by adding a good business with solid cash flow and attractive returns to a bad business that was destroying capital. Obviously, as Buffett points out, he should have shut down the textile mills sooner, and just used National Indemnity to build what is now the company we know as Berkshire Hathaway. Two Mistakes to Avoid Two takeaways from this, which, in Buffett’s own words, were two of his greatest mistakes: It’s usually not a good idea to buy into bad businesses, even at a price that looks attractive If you are in a bad business, it probably doesn’t make sense to “double down” – for most of us, this could mean averaging down and buying more shares. In Buffett’s case, it was already a 25% position in his portfolio, and he “doubled down” by throwing good money after bad (putting National Indemnity – a good business – inside a textile manufacturer, instead of just a wholly owned company inside of Buffett’s partnership. The good news – things have worked out just fine for Buffett and for Berkshire. Although the textile mills unfortunately had to finally shut down for good, National Indemnity has come a long way since Buffett purchased it for $8.6 million in 1967 (see the original 2-page purchase contract here ; no big Wall Street M&A fees on this deal). National Indemnity now has over $80 billion of float and over $110 billion of net worth, making it the most valuable insurance company in the world. The insurance business that started with National Indemnity paid dividends to Berkshire last year of $6.4 billion, and holds a massive portfolio of stocks, bonds, and cash worth $193 billion at year end. Buffett estimated his decision to put National Indemnity inside of Berkshire instead of in his partnership ended up costing Berkshire around $100 billion. It’s refreshing when the world’s best investor humbly lays out two of his largest mistakes, his original thesis, and the thought processes he subsequently had in regard to those investments. It’s also nice to note that despite two large mistakes, things worked out okay. I own shares in Berkshire, purchased for the first time ever just recently, and I’ll write a post with a few comments on the recent 10-K and annual report soon.

Best And Worst Q1’16: Mid Cap Blend ETFs, Mutual Funds And Key Holdings

The Mid Cap Blend style ranks sixth out of the twelve fund styles as detailed in our Q1’16 Style Ratings for ETFs and Mutual Funds report. Last quarter , the Mid Cap Blend style ranked eighth. It gets our Neutral rating, which is based on aggregation of ratings of 18 ETFs and 319 mutual funds in the Mid Cap Blend style. See a recap of our Q4’15 Style Ratings here. Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all Mid Cap Blend style ETFs and mutual funds are created the same. The number of holdings varies widely (from 19 to 3336). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Mid Cap Blend style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Four ETFs are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Five mutual funds are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. The PowerShares S&P MidCap Low Volatility Portfolio (NYSEARCA: XMLV ) is the top-rated Mid Cap Blend ETF and the ClearBridge Mid Cap Fund (MUTF: LSIRX ) is the top-rated Mid Cap Blend mutual fund. XMLV earns an Attractive rating and LSIRX earns a Very Attractive rating. The Guggenheim Raymond James SB-1 Equity ETF (NYSEARCA: RYJ ) is the worst-rated Mid Cap Blend ETF and the RBC Mid Cap Value Fund (MUTF: RBMAX ) is the worst-rated Mid Cap Blend mutual fund. RYJ earns a Neutral rating and RBMAX earns a Very Dangerous rating. Amdocs (NASDAQ: DOX ) remains one of our favorite stocks held by LSIRX and earns a Very Attractive rating. Since 1998, Amdocs has grown after-tax profit ( NOPAT ) by 16% compounded annually. The company has earned a double-digit return on invested capital ( ROIC ) every year for the past decade and currently earns a 12% ROIC. The impressive profit growth achieved by Amdocs has not gone unnoticed, as the stock is up 90% over the past five years. However, shares remain undervalued. At its current price of $55/share, Amdocs has a price-to-economic-book value ( PEBV ) ratio of 1.0. This ratio means the market expects Amdoc’s NOPAT to never meaningfully grow from current levels. If Amdocs can grow NOPAT by just 6% compounded annually for the next decade , the stock is worth $72/share today – a 29% upside. Zayo Group (NYSE: ZAYO ) is one of our least favorite stocks held by Mid Cap Blend ETFs and mutual funds. Zayo earns a Dangerous rating. Since Zayo’s IPO, the company’s economic earnings have not only remained negative, but also declined from -$137 million in 2013 to -$165 million over the last twelve months. Over this same time, Zayo’s ROIC has consistently ranked in the bottom quintile and is currently a bottom quintile 4%. Despite the deterioration of the business, ZAYO remains overvalued. To justify its current price of $24/share, Zayo must grow NOPAT by 13% compounded annually for the next 13 years . The expectations embedded in the stock price provide no room for error and only large downside risk. Figures 3 and 4 show the rating landscape of all Mid Cap Blend ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

U.S. Hires More Than Expected In Feb.: ETFs And Stocks To Buy

The U.S. labor market continued its strength with solid hiring in February, easily dodging the global slowdown and a tumultuous stock market. The economy added 242,000 jobs in February, much above the market expectation of 190,000. The majority of the additions were seen in healthcare, retail, bars and restaurants, and construction that more than offset the decline in the mining sector. Unemployment remained unchanged at an eight-year low of 4.9% while job gains for December and January were revised upward by a combined 30,000. However, average hourly wages unexpectedly dipped 0.1% after a strong 0.5% increase in January. This reflects the first monthly drop since December 2014 and lowered the year-over-year wage increase to 2.2% from 2.5% for January. The robust data eased fears of a recession in the U.S. and infused further signs of confidence into the economy. Investors’ sentiment thus turned toward risk-on trade once again. While a solid hiring number is strong enough to support the Fed’s gradual interest rates hike this year, tepid wage growth remains a matter of concern. Market Impact The news extended the U.S. stock market’s three-week winning streak seen this year. In particular, the Dow Jones Industrial Average climbed to over 17,000 for the first time since January 5 while the S&P 500 surpassed 2,000 during the trading session but closed at a lower level. Yields on two-year and 10-year Treasury bonds soared to one-month high levels but fell at the close. On the other hand, U.S. dollar remained volatile given that the solid pace of hiring was tarnished by a drop in average hourly wages. Given this, we have highlighted three ETFs and stocks that will be the direct beneficiaries of job gains and see smooth trading in the days ahead. ETFs to Buy PowerShares DB USD Bull ETF (NYSEARCA: UUP ) A healing job market and the resultant improving economy will pull in more capital into the country and lead to appreciation of the U.S. dollar. UUP is the prime beneficiary of the rising dollar as it offers exposure against a basket of six world currencies – euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of the U.S. Treasury securities. In terms of holdings, UUP allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound. The fund has so far managed an asset base of $830.6 million while sees an average daily volume of around 1.6 million shares. It charges 80 bps in total fees and expenses, and lost 0.3% on the day following the jobs report. The fund has a Zacks ETF Rank of 2 or “Buy” rating with a Medium risk outlook. SPDR Homebuilders ETF (NYSEARCA: XHB ) Solid labor market fundamentals along with affordable mortgage rates will continue to fuel growth in a recovering homebuilding sector, creating a buying opportunity in homebuilders and housing-related stocks. In addition, slower and gradual rate hikes will not impede the growth prospect of the sector, at least in the short term. The most popular choice in the homebuilding space, XHB, follows the S&P Homebuilders Select Industry Index. In total, the fund holds about 37 securities in its basket with none accounting for more than 5.21% share. The product focuses on mid-cap securities with 67% share, followed by 24% in small caps. The fund has amassed about $1.5 billion in its asset base and trades in heavy volume of more than 3.7 million shares. Expense ratio comes in at 0.35%. XHB added 0.2% on the day and has a Zacks ETF Rank of 2 with a High risk outlook. SPDR S&P Retail ETF (NYSEARCA: XRT ) Retail will also benefit from accelerating job growth though soft wage growth points to reduced spending power. XRT tracks the S&P Retail Select Industry Index, holding 100 securities in its basket. It is widely spread across each component as none of these holds more than 1.78% of total assets. Small-cap stocks dominate about three-fifths of the portfolio while the rest have been split between the other two market cap levels. XRT is the most popular and actively-traded ETF in the retail space with an AUM of about $617.2 million and average daily volume of around 4.4 million shares. It charges 35 bps in annual fees and gained 0.5% on the day. The product has a Zacks ETF Rank of 1 or “Strong Buy” rating with a Medium risk outlook. Stocks to Buy Though several sectors will benefit from healthy hiring, the direct beneficiary is the staffing industry. The industry bodes well at least for the near term given its superb Zacks Industry Rank (in the top 11%) at the time of writing. Investors seeking to ride out the optimism could look at a few top-ranked stocks handpicked by us using our Zacks Stock Screener . These stocks have a Zacks Rank #1 (Strong Buy) or #2 (Buy), a Growth or Value Style Score of B or better, and an above-average industry earnings growth of 13.7%. Cross Country Healthcare, Inc. (NASDAQ: CCRN ) Based in Boca Raton, Florida, Cross Country is a leading healthcare staffing services’ company which primarily focuses on providing nurse and allied, and physician staffing services and workforce solutions. The stock is expected to deliver year-over-year earnings growth of 26.9% in fiscal 2016. It shed 1.2% in Friday’s trading session and currently has a Zacks Rank #2 with a Growth Style Score of “A”. TrueBlue, Inc. (NYSE: TBI ) Based in Tacoma, Washington, TrueBlue is a leading provider of staffing, recruitment process outsourcing, and managed services in the United States, Canada and Puerto Rico. The company’s earnings are expected to growth 48.4% year over year in fiscal 2016. TBI gained 0.7% on the day and has a Zacks Rank #1 with a Value Style Score of “B”. Insperity, Inc. (NYSE: NSP ) Based in Kingwood, Texas, Insperity provides an array of human resources and business solutions to enhance the performance of small- and medium-sized businesses in the United States. The company has an incredible earnings growth projection of 53.8% for fiscal 2016. The stock was down 0.2% in Friday’s session and has a Zacks Rank #1 with Growth and Value Style Scores of “A” each. Original post