Buffett’s Letter

2013 March 3
by SJ Leeds

Help a young guy out!  One of my close friends has a son who is a junior at Princeton.  He’s on Princeton’s basketball team, is a great young man and he’s looking for a summer internship.  He’d love to work at a sports-related business but would be excited to have any other great opportunity.  If you’d like his resume, just send me an email.


Now, on to today’s blog…


Warren Buffett published his annual letter to his shareholders.  Here were some of the most notable comments:


Small acquisitions.  “Bolt-on” purchases (where small companies are bought to add on to existing businesses) are low risk, don’t burden the headquarters and expand the scope of proven managers.


What uncertainty?  There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash).  Yet, Berkshire spent a record $9.8 billion on plant and equipment in 2012 – 88% of it in the U.S.


Ignore the doomsayers.  Regardless of what the pundits are saying, “every storm runs out of rain”.


The future is always uncertain.  A thought for my fellow CEO’s: Of course, the immediate future is uncertain; America has faced the unknown since 1776.  It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them.


U-S-A, U-S-A.  American business will do fine over time.  And stocks will do well just as certainly, since their fate is tied to business performance.


We’ve been through hard times before.  Investors and managers are in a game that is heavily stacked in their favor.  The Dow Jones Industrial Average advanced from 66 to 11,497 in the 20th century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions.  And that gain didn’t include dividends!


Don’t try to time the market.  Charlie (Munger) and I believe it’s a terrible mistake to try to dance in and out of it (the market) based upon the turn of tarot cards, the predictions of “experts” or the ebb and flow of business activity.  The risks of being out of the game are huge compared to the risks of being in it.


How Berkshire creates value.  Berkshire builds intrinsic value by (1) improving the earning power of our subsidiaries; (2) further increasing their earnings through bolt-on acquisitions; (3) participating in the growth of the companies that we invest in; (4) repurchasing shares when they are selling at a meaningful discount to intrinsic value; and (5) making an occasional large acquisition.


Insurance companies have problems.  Insurance company earnings are still benefiting from bonds that were purchased with higher yields than are available right now.  In effect, today’s bond portfolios are wasting assets.


EBITDA is not cash flow.  Our definition of interest coverage is pre-tax earnings / interest, not EBITDA/interest, a commonly-used measure we view as deeply flawed.


Accountants aren’t nearly as interesting as us finance guys.  After discussing accounting issues, he said, “and that ends today’s accounting lecture.  Why is no one shouting, “More, more?””


You have to pay for quality.  A common Buffett comment: It’s far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.


Buying newspapers.  Interestingly, Berkshire is buying some newspapers right now (which doesn’t necessarily sound consistent with buying “good businesses”).  While he says that industry profits are certain to decline, he’s buying papers in small cities and towns where there is a real sense of community.  He argues that people want to know local news and there’s no substitute for a local paper.  He’s looking for papers in tightly bound communities and he’ll only buy papers that have a sensible internet strategy.


Investing in a public company.  Buffett mentioned recent the recent purchase of $1.15 billion of DIRECTV, saying he only discusses investments that have meaningful size.


We don’t need no stinkin’ dividend.  Buffett addressed the issue of dividends (Berkshire doesn’t pay dividends).  He made the case that the best thing to do with earnings is:

1. reinvest in the business (projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors);

2. search for acquisitions unrelated to our current businesses – need to be meaningful and sensible

3. repurchase shares – this is sensible for a company when its shares sell at a meaningful discount to conservatively calculated intrinsic value.  Buffett argued that this is the surest way to use funds intelligently: it’s hard to go wrong when you’re buying dollar bills for 80 cents.

Buffett made other arguments against cash dividends, including the fact that you’re forcing all shareholders to incur taxes.


Have a great week.

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