Category Archives: Investment-Gurus

Harvesting the archives (1): AS Creation, Medtronic, Netflix


Keeping track of all the companies one has ever looked at is pretty hard. It is pretty easy to update the companies which are in the current portfolio, but in my case, I often forget about the companies which I have looked a couple of years ago but didn’t buy for one reason or another or sold them. One of the great things of blogging is that you can easily look at everything you have ever written. Especially in the current environment, where good value investing ideas are pretty hard to find, it might make sense to look back at companies one has researched sometimes ago and either sold or not bought. Maybe they have become interesting again ? For me it is a lot easier to update myself on a stock I have looked 3-4 years ago compared to looking (and digging) into a completely new stock.

So in this new series, I will look into stocks I have written about and either sold or rejected and try to find out if something has changed or if some lessons could be learned.

AS Creation

AS Creation was the first detailed stock analysis on the blog in December 2010 (in German). The company back then looked cheap: Single Digit P/E, historically a single digit p.a. grower, 30% market share in Germany and the potential upside of a Russian JV (Russia was supposed to be a growth market back then). After some quite significant ups and downs, the stock was sold in August 2013 because the margins didn’t mean revert and the Russian JV was already in some trouble under “non crisis” conditions.

Looking back, the decision to sell in June 2013 at ~34 EUR looks smart if we consider the chart although in between the stock went up to 40 EUR again:

Operationally, AS Creation was hit by several negative events: First, the bankruptcy of Praktiker impacted them in the German core business, secondly, their French subsidiaries suffered and finally, the Russian JV which had to suffer from delays has been clearly hit by by the current crisis. With regard to the German business I have the impression that they never really rebounded to their historical average, maybe they did profit from some kind of anticompetition arrangements, for which they were fined. An interesting detail: They were convicted to pay 10,5 mn EUR in 2014, but they seem to have appealed the decision. To my knowledge, no appeal was ever succesful.

In any case, I don’t think AS Creation is interesting at the current level of 30 EUR. At a 2014 P/E of 15-20 (before any extra write-offs on Russia) there seems to be quite some turn around fantasy being priced in.

From my side there were 2 important lessons:
1. Mean reversion on single stock basis is nit guaranteed
2. If you buy cheap enough, you don’t lose much if things go wrong.


Medtronic was introduced (in German) on December 31st 2010 and then kicked out in August 2011 because I didn’t feel comfortable with a large cap US stock.

Looking back, this clearly doesn’t look like the smartest decision I ever made. Back then, I sold Medtronic at a loss of around -19%. Since then, the stock showed a total return of 167% in EUR. One of the interesting things about Medtronic is that a lot of the performance came from multiple expansion.

When I sold the stock at around 32 USD, the stock was trading around 10 times trailing earnings (3,27 USD per share 2010). 4 years later, reported earnings 2013/2014 have been ~20% higher per share at 3,80 USD, but Medtronic is now trading at around 18,5 times trailing earnings.

What is even more interesting than that is the fact that in absolute terms, 2013/14 earnings are at exactly the same levels as 2010/2011. Profit margins are even lower than back then. What happened ? Well, as in many cases for US stocks, the company bought back shares aggressively. Still, both ROE and ROIC declined but shareholders don’t seem to bother.

So despite the big run up of the share price, I don’t think that selling the shares has been a mistake. From a fundamental view the company looks worse than back then, however investors seem to be so happy about buyback driven EPS gains that they are willing to pay a pretty high valuation for this.

You could have speculated on such an outcome but as a fundamental investor, this would not have been in line with my investment philosophy. And clearly, You cannot increase the value of the company forever just by reducing the share count.

Stand-alone I would argue that Medtronic is clearly overvalued, based on the stagnating profit and deteriorating profitability. However with the current Healthcare “merger mania” I would not want to short the stock either.


I briefly considered to skip the whole Netflix episode but then decided against it. Looking back, this clearly shows that one can do stupid things and still make money….

I shorted Netflix in January 2011 after a short thesis from Whitney Tilson. Luckily I was able to cover the short with a gain in September 2011.

Looking at the chart, we can see that despite extreme volatility, Netflix is now trading 3 times higher than when I covered the position:

The lessons here were pretty simple:

1. Don’t short “hot stocks” based on fundamentals. It is too volatile and just not worth it-
2. Stay away from whatever Whitney Tilson is recommending

Fundamentally, Netflix is on my “too hard” pile. I do think streaming is a big thing and will be even bigger in the future. However I have no idea how much money Netflix will actually be able to make.

Lancashire Group (ISIN BMG5361W1047) – The UK equivalent of Buffett’s National Indemnity ?

While I was writing this post which I do normally over 1-2 weeks, the excellent WertArt Capital blog has released a very good post on Lancashire a few days ago. I higly recommend to read the post as it contains a lot of usefull information.

This saves me a lot of time and I only need to summarize the highlights:

- Lancashire is a specialist insurance company which insures mostly short tail “Excess loss” type of risks. It was founded by Richard Brindle, an experienced underwriter

- Since founding & IPO in 2009, the company has shown an amazing track record. No loss year, 59% average combined ratio and 19,5% ROE is simply fantastic.
- the company has a very disciplined underwriting focused business model, investment returns are negligible
- focus in on capital allocation and efficiency. If rates are not good, Lancashire returns capital to shareholders
- good alignment of management and shareholders (majority of bonus depends if ROE hurdle of 13% + risk free is hit)
- The company looks cheap at ~8,5x P/E and 1,3 x P/B

For non-insurance experts a few quick explanations of insurance terms:

“Short tail” insurance business:

“Short tail” means that one is only insuring stuff where you pretty quickly see if there is a loss or not. For instance a “plane crash” insurance will be good for 1 year and if a plane crashes, the insurer will pay. After that 1 year there are no obligations for the insurer.

“Long tail” in contrast is an insurance policy which again covers a calendar year but where the damage can come up much later. A good example is D&O (director and officers) insurance. Often, when a big company goes bankrupt, some fraud etc. was involved at management level. Until a jury finally makes a verdict, many years can pass by but still the insurance company which has underwritten the policy remains liable. A good example is for instance the recent Deutsch Bank /Kirch trial where insurers will have to pay 500 mn EUR for something that happened 12 years ago.

Long tail has the advantage that the “float” can be invested long-term and illiquid, on the other hand the risk if a significant miss-pricing is much higher.

Excess Loss contracts

Excess loss contracts are contracts where the insurer only pays above a normally quite high threshold. This means that in normal cases, one does not need to pay but as a result premiums are lower than with normal contracts or “lower attachment points”. These kind of contracts are also often called “catastrophe risk” or “Cat Risk”. If such an event hits, then the hit will be big. Lancashire initially expected to make a loss 1 out of 5 years but up to now they had no loosing year. A company which has many excess loss contracts will report very good results in some years but very very bad in others.

What is the connection to Warren Buffett ?

Lancashire and Co. are relatively similar to Buffet’s National Indemnity Insurance, maybe the most overlooked part of his insurance empire after GEICO and Berkshire/General Re. Buffet has commented several times on National Indemnity and the competitive advantages of this company. The major competitive advantage of this business according to him was the ability NOT to write business if premiums are too low. The problem with this approach is of course that if you write less business, cost will be higher and the all important “Combined Ratio” (costs+claims divided by premium) will go up and investors will get nervous.

I wrote down this quote from last’s year Berkshire AGM from Buffett:

“I prefer the underwriters playing golf all day instead of underwriting risks at the wrong price. I don’t care of combined ratios grow well above 100% in such years.” For normal Insurance companies this is almost impossible to achieve as investors want to see increasing sales and profits any year and so most Insurance companies will underwrite no matter what the price is just to maintain the premium.

On the web I found similar quotes from him on the National Indemnity (NICO) which the bought in the 80ties:

Nevertheless, for almost all of the past 38 years, NICO has been a star performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today.

What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate.


Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly-priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s).

Additionally, Buffett is already participating in the London/Lloyd’s market via another structure. Last year, he underwrote a socalled “side car” deal with Aon. The deal is still controversial but indicates a change of how things are being done at Lloyds. Funnily enough, Lancashire CEO Richard Brindle called the Buffet/Aon deal “foolish” in an interview last year.

Why is the company cheap ?

1. In general, all the socalled “London market” insurers are cheap. Let’s look at the “London” peer group:

Name Est Price/Book Current Yr P/E P/E FY1 Current Div. Yld (%)
LANCASHIRE HOLDINGS LTD 1,24 8,76 8,77 8,26
HISCOX LTD 1,62 10,47 13,48 8,21
BRIT PLC 1,23 #N/A N/A 8,59 #N/A N/A
BEAZLEY PLC 1,55 8,11 9,55 10,00
AMLIN PLC 1,36 7,94 11,13 6,07

Compared to those London players, all European P&C Insurance peers trade on average at~ 2,2 x book and 12 x earnings. So why are the London insurers so cheap ? In my opinion, the answer lies in the cyclicality of the business similar to Admiral. The “London market” is even more cyclical as it is primarily an institutional price driven market. The London market specialises in large and complex risks with “natural catastrophe” exposure. Despite the headline news, in the last years there were very few NatCat events which really led to large insured losses. In those times, profit margin increase and there is big pressure to lower premium. As companies accumulate capital, the appetite for risk increases, which further lowers premiums. This works as long as either a large NatCat event happens or capital markets crash and the insurers then have to raise premiums in order to restore their capital levels.

2. Management and strategy change

Lancashire so far has shown excellent underwriting discipline and outstanding an outstanding ability to allocate capital. However in the last few months a couple of things have changed:

a) The founder & CEO has “retired” in April at an age of 54. I haven’t found out why. Since 2005 I would guess that he has earned 50+ mn GBP, maybe he thought that this is enough ? At least he got an extra 10 mn package according to this article. He has been selling shares before his retirement.

b) In a change of strategy, Lancashire bought at the end of 2013 a Lloyd’s syndicate called Cathedral for ~200 mn GBP. Although the Lloyd’s business is not necessarily bad business, it is clearly a change. Lloyd’s underwriting is often reinsurance in contrast to Lancashire’s direct insurance. In their previous reports they claimed that their strategy of insuring directly was a competitive advantage. The Lloyd’s market on the other side is mostly reinsurance and more vulnerable.

c) Finally, after having been invested in short-term no-risk bonds since their IPO, they suddenly disclosed beginning at year-end 2013 that they now invest also into stocks and “Low volatility” hedge funds. Most likely not a good idea at this point.

For me, the cyclicality of the business itself would be no problem. But the combination of Management change and strategy change is very hard to swallow. I would happily invest if there would be EITHER a management change OR a strategy change but not both.


To quote Donald Rumsfeld, those two changes lead Lancashire into the “unknown unknowns” territory. Sure, the new CEO is at Lancashire since 2007 and an underwriter, but overall I am not sure if the superior capabilities of the forme CEO have been “institutionalized” in the 8+ years of company history. Having three platforms instead of one sounds great, but it can also mean a loss of focus. So at the moment, Lancashire for me is not a “buy” as I do not have a clear idea how and if they can replicate their past results. T

However in general, the business model is attractive and the “London Insurers” could become interesting, especially if the market softens further so I will try to look into the others at some point in time.

Edit: I have just seen via the “Corner of Berkshire and Fairfax” board a link to an “Insurance Insider” article which states that the former CEO has completely sold out and is expected to launch a new company. A reason more not to rely on past results as this business is very dependent on the persons and the old CEO wil be a pretty tough competitor if he starts over again.

The German Dax at 10.000 – looking back

Following Mr. Draghi’s speach on Thursday, the German Stock Index DAX hit the 10.000 mark for the first time in history soon thereafter. Many major publications directly came out with headlines along the line “DAX 10000 – what’s next” and speculated where the DAX might go.

In contrast to that and only for reasons of personal entertainment, I want to take a look back into the DAX history. The DAX was introduced 26 years ago in July 1988 by the German Stock Exchange in order to introduce a modern, performance based stock index. The linked Wikipedia site gives a great overview on the history of the DAX and the change in constituents. Mathematically, the DAX times series was based on 31.12.1987 with a starting value of 1.000 although there exist some “Virtual” time series going back much further.

Just a few interesting facts about the DAX:

- only 15 of the original constituents are still in the DAX
- 3 (or 10% of the original 30) actually went bankrupt
- the best years since 1987 have been 1993 with +46,71% and 1997 with +47,11%
- the worst year were 2002 with -43,94% and 2008 with -40,37%
- the biggest cummulative loss was the 2001-2003 period with a cumulative loss -58,9%
- the Dax rarely ends up pruducing single digit returns over a full calender year. Only 5 out of the last 26 years produced “single digit” returns. So yes, long term stock returns might be single digits but short term single digit returns are an exception

Neverthess, the 10.000 level represents an annual return of ~9,02% over 26,5 years (from December 1987 until May 2014). This compares with around 10,1% for the S&P 500 (in EUR).

For me personally, the implementation of the Dax coincidently equals almost exactly when I bought my first stock. The first Stock I bought was a company called Hoesch in September 1987. I remember this so well because just a few weeks later, the “Black october of 1987″ hit me with full force. I had used half of my earnings from a vacation job. As I wanted to increase my position after the crash, the people at the bank refused to take my order because they said that stocks are only for gamblers. As I was not yet of legal age back then, I had to come again with written permission of my parents to buy stocks.

This leads to another question:

Was this huge 26 year rally predictable or not ?

3 years ago I had reviewed the original “Market Wizards” from Jack Schwager which contains interviews with many then famous traders and hedge fund managers. Overall, one year after th 1987 crash, the sentiment was very very negative.

As I did not find historical P/Es for the Dax in 1987/1988, let’s look at this table of historic P/Es for the S&P 500:

31.12.1973 12,3
31.12.1974 7,3
31.12.1975 11,7
31.12.1976 11,0
30.12.1977 8,8
29.12.1978 8,3
31.12.1979 7,4
31.12.1980 9,1
31.12.1981 8,1
31.12.1982 10,2
30.12.1983 12,4
31.12.1984 9,9
31.12.1985 13,5
31.12.1986 16,3
31.12.1987 15,6
avg 10,8

Someone like John Hussmann might have said that stocks have nowhere to go as the P/E even after the 1987 crash was ~50% higher than the preceeding 15 year average. At the and of 1987, 10 30 year US Treasuries were yielding around 9%, another argument why stocks didn’t look that “apetizing” at that point in time. Why bother with stocks if you can earn double digits with corporate bonds any time ?

What followed

Looking back, it is easy to point out some of the events which led to this remarkable run especially for the DAX over the last 26 years:

- Communism broke down (“Peace dividend”)
- the Eurozone was created, stimulating cross border trading, increasing competition
- technology change (PC, Internet, Mobile)
- Corporate taxes in Germany went down form >50% to ~30%
- interest rates declined for now 25 years in a row
- old crossholding structure (“Deutschland AG”) dissolved, more professional management, foreign investors
- the BRIC story unfolded, further possibilities to export “core competency” goods like machinery and cars

In 1987/1988, few market pundits did even predict a single one of those factors. That’s why I think that just looking into the rearview (valuation) mirror should not be the only tool in the investing toolbox. Past P/Es will not predict future seismic shifts. On the other hand, one should not rely on such evcents happening over and over again and boosting share prices further. Clearly, interest rates and taxes will not fall that much lower and the effect of the end of Communism will not repeat itself.

For me the major conclusion is the following: Do not rely on any one system which tries to predict the future and/or future returns. Keep an open eye on everything, from valuations to macro economic factors and political shifts. Be prepared for surprises. Inthe long term, many surprises turned out to be positive for the economy and stock return.

Some musings on the Dax constituents

Just for fun, I created a table with the long term performance of the 15 “surviving” Dax constituents. Unfortunately I only got performance numbers back to 1992, but the p.a. Performance of the DAX was quite similar. lets look at those 15:

1987 Still in DAX Comment LT Perf (08/1992) p.a.
DAX     545,14% 8,95%
Allianz * 1   177,55% 4,80%
BASF * 1   3650,23% 18,12%
Bayer * 1   1598,15% 13,90%
BMW * 1   1723,82% 14,28%
Commerzbank * 1   -70,14% -5,40%
Continental 1   1962,28% 14,92%
Daimler-Benz (*) 1   90,50% 4,22%
Deutsche Bank * 1   89,57% 2,98%
Deutsche Lufthansa * 1   615,84% 9,47%
Henkel * 1   1200,08% 12,51%
Linde * 1   699,66% 10,03%
RWE * 1   308,71% 6,68%
Siemens * 1   742,92% 10,29%
Thyssen (*) 1   89,98% 4,32%
Volkswagen * 1   1690,10% 14,18%

Not surprisingly, financial stocks do not look good here. Overall, companies which are considered “well managed” did quite well such as Henkel, Bayer, BMW, Linde. Surprising for me is the fact that Lufthansa actually outperformed the DAX as well as Siemens.

Now let’s take a quick look at the new stocks. If I didn’t have returns from 1992, I made a comment:

    Total p.a. Perf. Since
Adidas 1   896,84% 13,23% 1995
Beiersdorf 1   1658,99% 14,09%  
Deutsche Börse 1   335,79% 11,74% 2001
Deutsche Post 1   103,80% 5,41% 2000
Deutsche Telekom 1   62,22% 2,80% 1996
EON 1   485,63% 8,46%  
Fresenius 1   4651,42% 19,42%  
Fresenius Medical Care 1   174,05% 5,90% 1996
HeidelCement 1   242,80% 5,83%  
Infineon 1   -80,66% -10,95% 2000
K&S 1   3084,30% 17,24%  
Lanxess 1   302,98% 16,11%  
Merck 1   555,53% 10,64% 1995
Munich Re 1   300,42% 7,24% 1994
SAP 1   3502,32% 19,98%

Not surprisingly, the best “newcomers” also lead the total Dax performance. Smaller companies which grow big are always the best investments, although it is often hard to identify them before.

Finally one other table. Let’s look at some of the best performers and their historical P/Es:

31.12.1992 28,6 24,4 19,6 18,9 11,4
31.12.1993 35,2 25,8 25,7 22,8 28,0
30.12.1994 19,4 36,7 15,0 20,6 14,6
29.12.1995 33,0 55,2 18,4 18,9 7,8
31.12.1996 64,4 52,1 25,9 28,7 14,4
30.12.1997 49,2 61,1 29,5 46,8 12,0
30.12.1998 30,8 71,5 32,8 30,4 11,8
30.12.1999 27,1 83,7 26,2 32,5 25,3
29.12.2000 37,7 60,0 21,7 41,9 23,6
28.12.2001 183,3 78,5 18,3 38,1 20,7
30.12.2002 10,8 46,3 20,0 31,3 13,9
30.12.2003 23,0 38,1 17,1 27,3 27,5
30.12.2004 18,2 30,9 5,3 21,9 14,5
30.12.2005 20,1 31,5 16,2 23,7 11,3
29.12.2006 23,5 26,2 18,9 16,7 11,6
28.12.2007 21,5 22,3 18,1 27,2 12,1
30.12.2008 21,2 15,5 54,7 16,8 8,9
30.12.2009 14,2 22,3 26,4 27,8 28,2
30.12.2010 16,3 24,9 18,1 29,7 12,0
30.12.2011 16,9 14,0 16,7 39,8 8,0
28.12.2012 16,3 25,8 18,3 31,6 13,6
30.12.2013 19,7 22,3 23,1 31,3 14,7

We can easily see that quality and growth NEVER is cheap. I am not sure if that Henkel 2004 P/E of 5 is incorrect data, but the solid “quality stocks” always traded “richly” and nevertheless delivered outstanding long term performance. Only BASF, as a “quality cyclical” company has been available at single digit P/Es at some years.

So after all, this is wat Warren B. likes to tell us: In the long term, quality does seem to beat anything else, especially if you factor in taxes, trading costs etc.


So what does this all tell us ? I am afraid that I cannot come up with some “Magic Formula” to identify future winners. Nevertheless, I think the look back emphasizes three of Warren Buffet’s main points:

1) over the long term, stocks have been a unbeatable compounding machine. A return 10 times the original inevstment in 26 years despite several devasting crashes speaks for itself

2) over such a long time horizon, it seems that “quality buy and hold” seems to be at an advantage at least for large caps. Yes, introducing a backtested system (market timing, EV/anything) could generate fantastic returns as well, but just buying and holding well managed companies did produce spectacular returns

3) Just buying the index and sitting on one’s ass would have beaten almost all active strategies. To be fair although, the first DAX index funds were available mid/end 90ties…..

P.S.: To finish the story: What happend to my first stock, Hoesch AG ? Hoesch was taken over by steel company Krupp which itself merged with Thyssen. If I would held it all the time, it would have been a pretty weak investment……

The Warren and Charlie Show

This year I fulfilled myself a long dream: I joined the pilgrimage to Omaha in order to listen to these 2 elderly Gentlemen

Ähhhh sorry,that was the wrong picture, I actually listened to those 2 Gentlemen

I guess you can easily find transcripts and quotes of the meeting in many places for instance here, or here.

So instead of doing this once again (and by the way a I did not take notes….), I will just make a few random observations:

1. I didn’t expect any “actionable investment ideas” and there were none

2. As a “first timer”, I found the event genuinely entertaining. They make a very good show. The movie was great and the 2 guys are really funny.

3. The questions from the audience were a lot better than in any other shareholder meeting I have been

4. Doug Kass as the evil short seller was relatively tame. He mostly asked about the obvious succession issue

5. In general, the meeting was a lot about succession, Buffet said many times “when I will be gone”

6. Buffet thinks there is no need to split the company. Berkshire’s “culture” will prevail.

7. However he indicated that Berkshire would be prepared to buy a lot of stock back at the right price

8. Sometimes the answers were a bit shallow. For instance when someone asked why Iscar is better than Sandvik (i.e. which moat), the answer was “better management” or when asked about the moat of IBM he talked about a pension problem. Buffet surely knows better but I guess he is not sharing everything with his shareholders.

9. The exhibition of the Berkshire companies looked liked a flea market to me. Maybe its my European taste but i found that they sold quite crappy products.

10. Buffet was slightly subdued about growth in America for the next few years (“New Normal” anyone ?)

11. Some Omaha restaurants behave like cafes at the St. Marcus place in Venice, Italy. One night we went to the “Chophouse“. “Unfortunately” the cheapest wine at 60 USD/bottle (!!!!) was not available any more, the second cheapest was already 100 USD …..additionally they tried to talk us into ordering magnum bottles at 295 USD … DON’T GO THERE.

The two Buffet quotes I wrote down were those:

Interest rates are to asset prices what gravity is to the apple. With such low interest rates there is not a lot of gravity for asset prices.

For many companies book value has almost no correlation to intrinsic value

Would I go there again ? I have to admit that for the shareholders meeting alone I am not sure. The whole trip is quite expensive and time consuming. However I had the privilege to attend a 2 day (invitation only) value investing conference just before Saturday in Omaha which was absolutely fantastic !!!

I met a lot of very nice people who to a large extent were very good or even outstanding value investors. Many ideas were shared and interesting discussions were made.

The whole package (conference + shareholder meeting) is definitely worth the trip.

What were my take aways ?

The “hard” take aways were:

and of course these:

And I might have some posts about some ideas which have been discussed soon……

“The death of value investing”

There was a quite provocative article with the same headline “The death of value investing” on Business Insider a few days ago.

Why should one take such a Business Insider article serious at all ?

Well, at first, this was not written by some lowly paid BI staff but from Marc Andreesen and Ben Horowitz, two venture capital legends with currently 3 bn under management. Andreesen by the way was one of the creators of MOsaic, the first web browser and founded Netscape.

Let’s look at their article:

Most of the best investors in the world are considered value investors. Well, times are changing — the destructive power of technology is starting to break down companies faster than ever.
Value investing is an investment philosophy that evolved based on the ideas that Ben Graham and David Dodd started teaching at Columbia Business School in 1928. Since I started my career as an investor, value investing was the holy grail of investing.

Hmm, I am not sure about that one. I always thought that value investing is rather a minority strategy…but ok.

There are many interpretations of what value investing is, but the basic concept is as follows: essentially you want to buy stocks at a discount to their intrinsic value. Intrinsic value is calculated by taking a discount to future cash flows. If the stock price of a company is lower than the intrinsic value by a “margin of safety” (normally ~30% of intrinsic value), then the company is undervalued and worth investing in.

That part is OK although I am not sure where have the 30% “margin of safety”. But then it gets interesting:

Generally, value stocks are companies that are in decline but the market has overreacted to their situation and the stock is trading lower than their intrinsic value.

Hmm, that is in my opinion only true for the original Graham “Cigar Butts”, but lets move on:

The classic case is Research in Motion (RIM). In January 2007, RIM was trading at a high 55x PE multiple. Over in Cupertino, a computer company called Apple had reinvented itself as an MP3 player company and was now unveiling a new phone set to launch in the summer. By the end of December 2009, market share for Apple’s iPhone iOS as a percentage of US smartphone OS was 25% while RIM had increased from 28% to 41% in that same period. Though RIM had grown market share, fears of iOS growth had toppled the PE multiple to ~17x.

Many traditional, value investors sat back and thought, “Well, RIM is holding up pretty well compared to the iPhone, yet their PE multiple is getting destroyed.” It’s trading at near the historical average S&P 500 PE multiple of 15x. Apple hasn’t historically been strong in the enterprise, so maybe iPhone will just be a consumer phenomenon that doesn’t break through to business users. Android is irrelevant with 5% market share. The smartphone market is growing rapidly and RIM is the clear leader. RIM is still growing north of 35% and generating nearly $2.5B in net income. I think RIM looks cheap!
Two years later, RIM was trading at a 3.5x PE multiple and topline growth had screeched to a halt. Market share for RIM had contracted to 16% while iOS and Android combined for 77% market share. In fact, in 2012, RIM posted a net income loss of $847mm. Investors lost a ton of cash and were left scratching their heads.
How did this happen so quickly? Why did net income fall off a cliff? Why now?

They then go on to explain that technology changes faster and faster, mostly because of

1. Technology adoption accelerating
2. Internet way of life
and what they call: 3. Software Eating the World

Their final verdict is clear:

With technology upending markets, remaining a value investor is a death sentence. In the case of RIM, the company thought that their scale was defensible and stopped innovating on the operating system, favoring battery life instead. Apple’s iPhone operating system and associated software was an order of magnitude better than RIM and attracted consumers. Interestingly enough, Apple is dangerously close to losing their own software battle to Google with mobile versions of Google Maps, Gmail and Google voice being far better than their iOS counterparts.

While there may still be opportunities for value investing, you need to be cautious of businesses that appear to be on a slow decline. With the rate of technology adoption accelerating, Internet being a way of life and software consuming the world, businesses who refuse to embrace or adapt don’t just slowly decline; they fall off a cliff and take their cash flows with them.

The final statement in my opinion is both, partly wrong and partly very important for value investors.

What A&H describe is what is known to value investors as a Value Trap. A superficially cheap stock, which however for different reasons is in terminal decline. This is clearly not restricted to technology stocks, although there it is quite obvious.

Even the most famous value investors are not immune against this, as Seth Klarmann’s unsuccessful investment in Hewlett Packard showed.

Interestingly, short seller Jim Chanos (who I consider to be one of the best value investors ever) basically says the same thing:

You have to be very careful, because we looked at our returns over the past 10 years, and, particularly since the advent of the digital age, some of our very best shorts have been so-called value stocks. One of the differences in the value game now versus, say, 15 or 20 years ago, is that declining businesses, while they often throw off cash early in their decline, find that cash flow actually reaches a tipping point and goes negative much faster than it used to.

I think this is a very important point here: Low valuation (low P/E, low P/B) and/or high FCF yields based on past data are by no means a guarantee for superior investment returns. He directly confirms A&H in this paragraph:

The advent of digitization in lots of businesses also means that the timing gets compressed, meaning that you need to move quickly or you are roadkill on the digital highway. That’s true whether you look at companies like Eastman Kodak, or Blockbuster, or the newspapers. Value investors have been drawn to these companies like moths to the flame, only to find out that the business has declined a lot faster than they thought and that the valuation cushion proved to be anything but.

I think this is also one of the reasons, why many of the older “Quantitative Value strategies”, such as Dreman’s or O’Shaugnessey don’t work so well any more.

To summarize it bluntly up to this point: If you think value investing is only about buying low P/E and/or low P/B or low P/FCF stocks, then you will most likely be in for a quite nasty surprise, especially if you invest in anything that is subject to the technological changes as described above. Many of thse companies will drop off much more quickly than in the past and reversion to the mean will not happen.

On the other hand, I don’t think that value investing is dead, but it has rather evolved. If you look at Warren Bufft (and Todd Combs and Ted Weschler of course), Buffet style value investing looks of course very different. He invests at much higher P/Es and P/B, however still with a lot of margin of safety as he is able to factor in the value of potential “moats”.

Other value investors like Seth Klarmann for instance go into other asset classes or “special situation” investing where “margins of safety” are created via forced selling of market participants.

Funnily enough, when I was googling “The death of value investing”, an article with exactly the same title popped up from 2008, written by the quite famous author Edward Chancelor.

He refers to mistakes made by some “value investors” at that time:

The housing bubble, however, changed many facts. But some of the world’s leading investors appeared not to have noticed. First, several prominent names piled into housing stocks when they were selling at around book value. This proved a disastrous move as falling land prices and slowing sales generated massive losses for homebuilders. Then, some of the same investors charged into banks, figuring they were cheap. That also turned out to be a poor idea.

As we know now, Value investing made it at least another 5 years and 2008 and 2009 provided the best opportunities for open minded value investors in a generation.


Clearly, Value Investing is not dead. It was not dead in 2008 and it is not dead now. But as the A&H well describe, “simple value” investing, i.e. just buying low P/E and P/B stocks is much more dangerous now that it was in the past.

For the “Normal” value investor, this means to put more effort in to identifying potential value traps. There is strong support to the thesis that declining companies, especially those subject to technological change, will “drop over the cliff” much faster than ever. So buying HP/Apple/ Micrososft/Intel/Solar/Media because it is so cheap at single digit trailing P/E minus cash should not considered to be a value investment unless you are really sure that sales and profits will not drop off similar to Nokia and RIM.

Value investing willneed to further evolve, but buying investments at a discount to a (carefully) determined intrinsic value will always be a good investment startegy.

Berkshire Hathaway 2012 listed stocks performance

I hope everyone has now read the 2012 annual Berkshire Letter which came out last week.

Among other stufff, Warren Buffet complained a little bit that he didn’t beat the S&P 500 based on the increase in Book Value at Berkshire.

Just for fun, I hacked in Berkshire portfolio.

In a first step I looked at all the disclosed positions above 1 bn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.8 16.1 8.9 1.05 8,715
Coca Cola 6.51% 19.6 5.3 16.6 14.0 0.72 14,500
Conoco Philips 9.20% 9.5 1.5 6.5 4.4 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.0 6.2 0.89 1,154
IBM 4.17% 13.7 12.4 11.6 9.4 0.91 13,048
Moody’s 51.86% 16.6 29.1 10.3 9.5 1.31 1,430
Munich Re 54.71% 8.1 1.0 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 2.0 10.8 8.5 1.16 1,097
POSCO 1.19% 8.3 0.7 9.0 6.4 1.01 1,295
Procter & Gamble 5.18% 19.4 3.2 14.4 11.9 0.64 3,563
Sanofi 34.20% 20.0 1.7 13.2 6.9 0.76 2,438
Tesco -8.20% 10.8 1.7 10.4 7.2 0.72 2,268
US Bancorp 20.96% 11.9 1.9 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.2 10.3 7.9 0.59 3,741
Wells Fargo 27.37% 10.7 1.3 #N/A N/A #N/A N/A 1.15 15,592
Total / Avg 17.56% 14.27 5.0 13.4 10.1 0.92 76,332

To add some value, I have added some valuation metrics and aggregated the performance based on year end values. Although this is not the 100% correct way to do this, we can see that the listed stock portfolio outperformed the S&P Total return index (+14.1%) by a margin of almost 3.5%. A very respectable outperformance for a 75 bn USD portfolio. One can also see that the Beta of the portfolio is clearly below 1, so the outperformance really looks like alpha. (EDIT: I do not know which Index Buffet used for his 16%, I took S&P 500 total return performance from Bloomberg).

From simple valuation metrics, the portfolio of course looks quite expensive. P/E of 14.4 is in line with the S&P 500, but it looks like that Berkshire doesn’t consider P/B as a meaningful metric for listed stocks anymore. Also, the average EV/EBIT of 13 and EV/EBITDA of 10 is far above I would be prepared to pay.

In a second step, I added all the stock positions which were disclosed by Berkshire plus anything available on Bloomberg with a value of more than 200 mn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.78 16.05 8.88 1.05 8,715
Coca Cola 6.51% 19.6 5.33 16.55 13.98 0.72 14,500
Conoco Philips 9.20% 9.5 1.47 6.54 4.38 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
IBM 4.17% 13.7 12.41 11.56 9.41 0.91 13,048
Moody’s 51.86% 16.6 29.11 10.29 9.48 1.31 1,430
Munich Re 54.71% 8.1 0.96 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 1.98 10.82 8.52 1.16 1,097
POSCO 1.19% 8.3 0.70 8.96 6.36 1.01 1,295
Procter & Gamble 5.18% 19.4 3.21 14.44 11.88 0.64 3,563
Sanofi 34.20% 20.0 1.74 13.22 6.88 0.76 2,438
Tesco -8.20% 10.8 1.74 10.40 7.15 0.72 2,268
US Bancorp 20.96% 11.9 1.86 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.21 10.27 7.86 0.59 3,741
Wells Fargo 27.37% 10.7 1.33 #N/A N/A #N/A N/A 1.15 15,592
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
Swiss Re 49.31% 6.8 0.92 #N/A N/A #N/A N/A 1.15 909
Washington Post 1.20% 17.6 1.16 9.27 4.52 0.81 704
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
Total / Avg 19.57% 14.4 7.6 13.6 10.1 0.94 85,653

A few observations here:

I do not understand, why DaVita was not included in the shareholder’s letter with a market value of 1.8 bn. Maybe they have forgotten this position ?

Secondly, including those additional ~10 bn of stocks increases the total performance of the total portfolio by an incredible 2%.

In a third step, I calculated the performance of what I would call the “Non Buffet” Portfolio, taking Direct TV from the annual letter and eliminating Swiss Re and Washington Post from the < 1bn list.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
Total / Avg 34.97% 15.2 33.6 15.3 9.9 1.07 8,862

And here we can see that Weschler and Combs really “shot out the lights”. 35% performance for 2012 is a fxxxing fantastic result. Ok, Beta is slightly above 1 but at least for 2012 the did a outstanding job. No wonder Buffet said that in his annual letter:

Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. They left me in the dust as well.

So even if some of the smaller stocks are “Warren & Charlie” stocks as well, Weschler and Combs showed them how its done at least with a smaller portfolio. Maybe the smaller size of the portfolio is the reason ?


Once again, the portfolio of listed stocks of Berkshire outperformed the S&P 500 by a nice margin. However it seems to be that Buffet’s “elephants” don’t have a chance against the smaller holdings of Weschler and Combs. Nevertheless, for the “lazy” value investor, copying the Berkshire portfolio looks still like a winning strategy.

Copying the “small” Berkshire stocks however looks like the absolute killer strategy.

Utility companies – The Warren Buffet perspective

In 2012, I sold my two utility stocks EVN and Fortum because I realised that I didn’t really understand the business model. I looked a little bit more general into utilities here, but with no real results. However,at least in Europe, the utility sector looks like one of the few remaining “cheap” sector.

If you don’t know a lot about a sector but need to start somewhere,it is always a good idea to look ifWarren Buffet has something to say about it

Although mostly his well-known consumer good investments like Coca Cola and Gilette are mentioned, Buffet runs a quite sizable utility operation called MidAmerican Energy.

Starting with the Berkshire 2011 annual report, let us look how the “sage” describes the business:

We have two very large businesses, BNSF and MidAmerican Energy, that have important common characteristics distinguishing them from our many other businesses. Consequently, we assign them their own sector in this letter and also split out their combined financial statistics in our GAAP balance sheet and income statement.
A key characteristic of both companies is the huge investment they have in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire. Our credit is not needed: Both businesses have earning power that even under terrible business conditions amply covers their interest requirements.

So let’s note here first: Buffet uses “large amounts” of debt for his utility company.

Just below we find the following statement:

At MidAmerican, meanwhile, two key factors ensure its ability to service debt under all circumstances: The stability of earnings that is inherent in our exclusively offering an essential service and a diversity of earnings streams, which shield it from the actions of any single regulatory body.

I would argue he second point is interesting: Diversification in utilities works across regulators, not necessarily geographic location.

What I found extremely interesting is that Buffet is allocating a lot of capital to the utility sector. Out of the 19 bn USD Capex in Berkies operating businesses from 2009-2011, MidAmerican Capex summed up to ~9 bn USD, so almost half of Berkies total Capex.

One can assume that Buffet is not making all share investment decisions nowadays, but I think capital allocation to operating companies will be still made by him personally.

Buffet seems also quite interested in renewable energy, as the following comment from the annual report shows:

MidAmerican will have 3,316 megawatts of wind generation in operation by the end of 2012, far more than any other regulated electric utility in the country. The total amount that we have invested or committed to wind is a staggering $6 billion. We can make this sort of investment because MidAmerican retains all of its earnings, unlike other utilities that generally pay out most of what they earn. In addition, late last year we took on two solar projects – one 100%-owned in California and the other 49%-owned in Arizona – that will cost about $3 billion to construct. Many more wind and solar projects will almost certainly follow.

Here, he also mentions that he doesn’t extract any dividends out of his utility group. He considers it a growth opportunity rather than a cash cow. I think this is also worth keeping in mind, as many investors would judge utility stocks mainly by dividend yield.

From the 2009 report we learn the following:

Our regulated electric utilities, offering monopoly service in most cases, operate in a symbiotic manner with the customers in their service areas, with those users depending on us to provide first-class service and invest for their future needs. Permitting and construction periods for generation and major transmission facilities stretch way out, so it is incumbent on us to be far-sighted. We, in turn, look to our utilities’ regulators (acting on behalf of our customers) to allow us an appropriate return on the huge amounts of capital we must deploy to meet future needs. We shouldn’t expect our regulators to live up to their end of the bargain unless we live up to ours.

This is as clear as it gets. Utilities are a “natural” monopoly. If you play by the rules (at least in the US), you are guaranteed a decent return.

In the same report Buffet once more explains why he is suddenly more interested in utilities:

In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite
willing to enter businesses that regularly require large capital expenditures.

From the 2008 report, this sentence is reinforcing Buffets strategy:

Indeed, MidAmerican has not paid a dividend since Berkshire bought into the company in early 2000. Its earnings have instead been reinvested to develop the utility systems our customers require and deserve. In exchange, we have been allowed to earn a fair return on the huge sums we have invested. It’s a great partnership for all concerned.

On acquisition of utilities, we can also find his thoughts in that report:

In the regulated utility field there are no large family owned businesses. Here, Berkshire hopes to be the “buyer of choice” of regulators. It is they, rather than selling shareholders, who judge the fitness of purchasers when transactions are proposed.

There is no hiding your history when you stand before these regulators. They can – and do – call their counterparts in other states where you operate and ask how you have behaved in respect to all aspects of the business, including a willingness to commit adequate equity capital.

When MidAmerican proposed its purchase of PacifiCorp in 2005, regulators in the six new states we would be serving immediately checked our record in Iowa. They also carefully evaluated our financing plans and capabilities. We passed this examination, just as we expect to pass future ones.

So being nice and trustworthy to the regulator is what counts in this business.

Finally let’s look at some “hard numbers” from MidAmerican, in order to be able to compare this to other utilities. I will use the MidAmerican 2011 annual report for this.

  2011 2010 2009 2008
Total Assets   47.7 45.7 44.7 41.4
Shareholders Equity   14.1 13.2 12.6 10.2
total financial debt   17.8 18.2 19.3 18.2
Sales   11.2 11.1 11.2 12.7
EBIT   2.684 2.502 2.465 2.828
Net Income   1.331 1.238 1.157 1.85
Int. Exp   1.196 1.225 1.257 1.333
Op. CF   3.220 2.759 3.572 2.587
Capex   2.684 2.593 3.413 3.937
ROE   9.8% 9.6% 10.2%  
NI margin   11.9% 11.2% 10.3% 14.6%
EBIT Margin   24.0% 22.5% 22.0% 22.3%
Debt/equity   126.2% 137.9% 153.5% 178.4%
EBIT/Int exp   2.24 2.04 1.96 2.12
ROA   2.9% 2.7% 2.7%

We can clearly see that this is low ROA business. Only the significant leverage allows Buffet to have ~10% ROE on average. Additionally, he seems to provide some “contingent” capital to MidAmercian, i.e. to promise a capital contribution of 2 bn USD if required. I think this keeps down the cost of debt without explicitly guaranteeing it. MidAmerican has a credit rating of “only” A- against Berkshire’s AA+. Also one can see that he reduced leverage over the last few years since taking over MidAmerican.

Nevertheless he seems to prefer this vs. returning cash to shareholders. Interesting.

So let’s quickly summarize Warren Buffet’s perspective on utilities as far as I understood it:

- he only started to invest into utilities relatively lately because he needs something where to invest his growing cashflows from the other operations
- he prefers regulated utility business, diversified over different regulators
- he invests a lot of money into renewable energy
- he uses significant leverage to achieve 10% ROE
- he is not looking at the busienss as a cash cow but a long term growth business and therefore does not extract any dividends

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