To sum it upfront: In my opinion there was nothing “really new” or spectacular in Buffett’s 2016 letter.
Operationally, 2016 was not such a good year for Berkshire, operating profit was flat and book value gain lower than the S&P. Nevertheless Berkshire’s stock price outperformed the S&P 500. Comprehensive income however was very good, around 50% better than 2015 (which was not very good).
Net tangible assets declined to around 170 bn from 186 bn mostly due to the Precision Cast Part acquisition which added more than 40 bn in intangibles.
I made some notes which might be interesting to some reader (or not).
Berkshire share repurchases:
The most interesting part from my side was where he writes about share repurchases in general and Berkshire in particular. I actually know some investors who treat the “Buffett put” at 120% of NAV as a real one, assuming that the stock price can never go below that level. This is what Buffet says:
Following my Old Mutual “sum of parts” valuation I saw the following Ira Sohn presentation of Exor Spa, the Agnelli family holding (FiatChysler, CNH etc.) as a potential “Sum of part” value investment.
To summarize the presentation in my own words:
- Exor Spa is basically a “Berkshire like” company at a “Graham” valuation
- Exor is managed by a “great capital allocator” and trades at a discount as people see it as an Italian company
- After the acquisition of Reinsurance Partner Re Exor should trade at similar valuations as Berkshire or Markel
- Big upside potential as FiatChrysler, Ferrari (and CNH) are severely undervalued (“Coiled springs”)
The study sees a potential upside of several times the current share price. They forecast a 150 EUR NAV per share (vs. ~50 EUR now and 30 EUR share prices), driven by a quadrupling in value of the FCA and the CNH stakes.
Everyone who has read Thorndikes book “The Outsiders” clearly knows that capital allocation& capital management is one of the most important factors in creating long term shareholder value. After I watched Thorndike give a briliant talk at Google on this topic, I decided to write down my own thoughts on the topic.
What is CAPITAL ALLOCATION & CAPITAL MANAGEMENT anyway ?
CAPITAL ALLOCATION is simply what you do with your profits/cash inflows once they are in your account. You can do a lot of things with it. Thorndike in the talk above uses 5 uses, I would add another 2 (in bold)
1. Reinvest: Maintain your existing assets/infrastructure/operations
2. Grow organically: Expand your business by buying more machines/outlets/opening stores etc.
3. Expand your business by M&A
4. Pay back liabilities (debt, payables, pension liabilities etc.)
5. pay dividends
6. buy back shares
7. just leave the cash on your account and wait for better opportunities
In late 2014 I started looking into oil related companies. I have looked at a couple of energy related companies like explorer Peyto, LNG liquification terminal Cheniere , Consol Energy and Gaztransport. I only bought Gaztransport which I then sold 6 weeks later. As I am still interested in the Energy sector, I will cover some stocks from time to time.
Kinder Morgan, the US pipeline owner/operator looks like another typical potential contrarian “Value investment”.
What I liked at first sight: Read more
Executive summary: Although American Express looks cheap based on their historic profitability, the company is subject to rapid technological change and fierce competition in the payment industry. To me it is not clear how this will work out going forward, so for the time being I will not invest but look deeper into the industry.
American Express is well known in value investment circles because Buffett owns ~15% of the company and made a lot of money with it.
Recently the stock price came under pressure mainly because:
- they lost a big co-branding contract (Costco) which will materialize in 2016
- EPS shrank for the first time since 2001
- lost a court case (vendors steering clients to cheaper cards)
- “fintech hype”: mobile payment & peer-to-peer lkoan platforms as disruptors
The stock price clearly has suffered and is down more than -40% from its peak in late 2014 /early 2015:
One general remark upfront: The 2015 annual report wasn’t that exciting in my opinion. Actually, I didn’t plan to write a post on it. However, after reading a couple of posts on the topic, I though maybe some readers are interested because I haven’t seen those points mentioned very often elsewhere.
- Bad year for GEICO
GEICO had a pretty bad year in 2015. The loss ratio (in percent of premium) increased to 82,1% (from 77,7%), the Combined ratio increased to 98% and the underwriting profit fell by -60%. Buffett talks about the cost advantage a lot in the letter, but the only explanation forthe increase in loss ratios are found in the actual report:
After bashing David Einhorn for his Consol Energy WACC assumption last week, by chance I read at the very good 25iq blog an article on how Buffett and Munger publicly speak about those things.
Indirectly, this is clearly a slap in my face because even the headline already says it all:
Why and how do Munger and Buffett “discount the future cash flows” at the 30-year U.S. Treasury Rate?
The post summarizes what Charlie and Warren have said over the years with regard to cost of capital and discounting. I try to summarize it as follows:
- They seem to use the same discount rate for every investment, the 30 year Treasury rate
- in a second step they then require a “margin of safety” against the price at offer
- they estimate cash flows conservatively
- Somehow Buffet seems to have a 10% hurdle nevertheless
- Buffett compares potential new investment for instance with adding more to Wells Fargo
So if Buffett doesn’t use more elaborated methods why should any one else ? Was I wrong to beat up David Einhorn because he used a pretty low rate for Consol Energy ? Add to this Mungers famous quote “I’ve never heard an intelligent cost of capital discussion” and we seem to waste a lot of time here, right ?