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Stocks B / Berkshire Hathaway


Subject:  Re: BRK Stock Return 1965 to Present Date:  6/11/2014  3:04 PM
Author:  michaelservet Number:  211358 of 257649

Pure dumb luck, of course. Actually, two very distinct elements of luck, as has been pointed out, not the least of which is the ‘hold’ part of ‘buy and hold.’ After all, anyone buying a dozen stocks during the ‘60’s and ‘70’s and sticking them in a drawer for the past half-century could quite possibly have a really nice surprise or two. So, let's just chalk it up to luck.

The question is, how purely random is this sort of luck? Is there any way to improve one’s odds?

Two of the factors that play into this might be
a) environment, and
b) information.

First off: early family environment. Buffett no doubt benefited early on from having a stockbroker as a dad, and visiting his office at age 11. You have to know that this world even exists to take an interest in it. There is no substitute for daily exposure to markets and perhaps more importantly, business dynamics at a young age.

I’m not in any way implying there are any similarities - at all - but at by that age I had hung out a bit on the floor of a regional exchange accompanying a relative who was a member. It seemed cool. It also occurs to me now that most kids hadn't had that experience, or leafed through Moody's, or had any number of experiences.

So we’re not talking about an environment where people are dabbling in investments, but where the financial aspects of businesses are a family’s life-blood. All the better if it’s a multi-generational thing, where habits and thought processes are passed along and modified over time. As in most things in life there is no substitute for early immersion.

Once someone is beyond their mid-teens it seems that this type of learning becomes so much more difficult – the mental models are then learned, and not just already part of the developmental fabric. And it’s more than just analytical tools. It’s a mindset where you are looking at something like a portfolio as the family business or family farm, rather than a transitory source of funding for future spending – on an education, house, or something. (Would you sell off your portion of the acreage for a new car, or even a new tractor?)

Additionally, families that live this know how very difficult it is for an outsider - a spouse or someone, no matter how well educated or intelligent - to really begin to understand this framework. The insider envisions building blocks while an outsider looking at the same portfolio sees something else, perhaps eventual purchasing power.

That is why whenever I think about it I am as critical as I am with Buffett’s designated keeper of the culture. Maybe he can say that since his twenties he has come to see the light, but that irreplaceable early immersion was clearly missing. I will risk obvious criticism here and draw a comparison to another public family: in my opinion the kind of immersion I am talking about is clearly evident in Donald Jr and Ivanka. Whatever you think of the family patriarch, you knew that by the time the offspring were in their twenties - and probably earlier - they had a very impressive immersion in, and grasp on, this culture. You know they get it.

Back to the ‘60’s: if during family backyard barbecues the main topics of discussion were the impact of the unfolding salad oil scandal; what Riklis, Ling, and Litton were buying next and how they were financing it; what was going on at an ITT or a Celanese – and the topics all seemed normal, and the discussions something to look forward to, then maybe there is a hint of an investment culture. If you have a daily curiosity about business and are in regular communication with others with similar mind-set, it is so much easier to occasionally be lucky.

I credit my own very occasional bits of luck to early environment.

When I was looking through old papers recently I found an old brokerage statement from the late 1960’s. I’d forgotten how much I appreciated that back then they only listed the security name and number of shares, with no cost or market value extensions. It made it so much easier to be sanguine about market gyrations. Either you liked what you owned or you didn’t. That, along of course with the high brokerage transaction costs and obscene bid-ask spreads really helped tamp down any short-term impulses. Those last two inefficiencies cost money and are best in the past, but I did like those statements.

On to “information” – and a caution here: a lot of this won’t particularly have direct relevance any more today, here in our information age.

Back in the 1960’s Buffett complained about the explosion of financial analysts by that time, compared to when he started, and how hard it was to find things anymore that weren’t already on somebody’s radar. By comparison to the free and easy access to information we have today with the fast and easy screening of the even the most obscure companies - we see now that that was nothing (though there is still one wonderfully inefficient corner of this universe still ripe for exploitation: private markets).

In some perverse ways I miss the days before the internet. One aspect then was the relatively inefficient dissemination of information. Back then you had to be on your toes if you wanted to stay informed, and actually develop some routines, spend some money, and even expend some physical effort. There is not the same advantage now in scouring the news each day and developing essentially a proprietary time-line on financial news. You only have to google a company and the history, details, and analysis of others is all there.

These days I like not to have to travel into the city, and it is nice to be able to pull up a 10k or something at will. Decades ago I was comfortable in the knowledge that there we only two government offices (in the entire country!) that I could go to when I wanted to peruse a company’s recent SEC filings. At least for awhile, my office was conveniently just a couple of blocks away from one; less than a five minute walk.

That proximity was like having super-hero powers. Of course back then you could pay a third-party service to go make a copy of a particular filing you needed and mail it to you, but that wasn’t quite the same as just perusing filings on those little microfiche cards at will. I remember getting the phone message that someone wanted to talk to me about some company or other, I took a walk over to the SEC library and looked through the company’s recent filings, and when I returned the call a half hour later was asked incredulously and somewhat anxiously “how do you know that!” There were some benefits to general inefficiency for those able to capitalize on it.

Likewise with subscriptions. If you subscribed to the WSJ - and if nothing else took time to scan the two “Who’s News” index listings of individual executives and companies every single day - you could be ahead of almost everybody. Another secret weapon overlooked by even many WSJ readers, particularly effective in ‘60’s and ‘70’s, was an information source hidden in plain sight: Women’s Wear Daily.

Beginning in the 1960’s WWD was a remarkable source of all kinds of business information, including even acquisition speculation and such. In 1968 guess who acquired this little gem: Capital Cities. Years later in the 1990’s, several of the Crain family's publication became good sources of early information (Crain’s, Advertising Age, etc) but in the ‘60’s and ‘70’s WWD was one to have. Back in the 1950’s and 1960’s Buffett had his own favorite trade journals. The trick was to pick one that always was ahead of the major news outlets, and not following.

Those born after about 1970 won’t appreciate this, but a Forbes subscription was a must back then, with Fortune a close second. And you couldn’t start the weekend without picking up Barron’s.

In 1969 Forbes ran a feature interview with Omaha investor Warren Buffett, discussing his past successes and his recent bargain purchase of textile manufacturer Berkshire Hathaway, at market prices of less than even the company’s working capital per share (more on that shortly). Berkshire could be had in the mid-$30’s by then. Five years later, in Forbes’ famous “oversexed man in a harem” interview, they were already referring to Buffett as “sage of Omaha”.

Unfortunately those articles didn’t hit the internet until many years later – potential investors had to have interest enough in general business and finance subjects to take the trouble to pick up and read the magazines at the time.

Similarly with a best-seller on investing. I was a big fan of the late Adam (George Goodman) Smith way back then, who among other things published his second bestseller “Supermoney” in 1972. In it he devotes a full chapter to Warren Buffett, including specifics on his bargain purchase of Berkshire. Berkshire shares could still be had for $80 seven years on (and better yet, $50 ten years on!) but by then it was certainly no secret as to what one of the then-notable investors of the time was up to.

1980 was a pivotal year for Berkshire in a number of respects. First off, if being featured in Supermoney back in 1972 wasn’t enough, in 1980, John Train’s popular “Money Masters” devoted a Chapter to Buffett alongside Templeton, Fisher, Graham, Neff, Soros, Lynch etc. Berkshire shares doubled that year, from the $200 per share range up into heady $400 per share territory.

To anyone following Berkshire even in the slightest during the 1970’s it was eminently apparent that there was another wonderful value company in the Berkshire universe that was destined for some kind of happy ending. The exact end-game was unclear, but in 1979 Berkshire slapped the Blue Chip annual report letter right into the back of the Berkshire report. The intertwining of the companies required a flow chart to even try to understand. Any reader knew something was going to have to happen.

Blue Chip was as close to a no-brainer as a Buffett follower could get, with Munger as CEO and Buffett essentially pulling the strings; Berkshire (initially Berkshire & Buffett himself) owning 60%; wholly owned subsidiaries like the immensely profitable fully-owned See’s Candy (easily funding losses at Blue Chip’s newspaper sub, the Buffalo Evening News); 80% each of Mutual Savings & Loan, Precision Steel and of Wesco; 35% of Pinkertons; and plenty of cash left over. The only very thin camouflage to the whole thing was the no-longer-relevant name. We could say the world was fooled by the name, but there it all was spelled out for anyone who cared to read the Berkshire annual report.

At the time my original cohorts and I we figured that the more we could obtain of that 40% of Blue Chip that Berkshire didn’t own, the better. Three of us jumped in. Fortunately the two others were more aggressive than I was and pretty much backed up the truck. I started to in the late ’70’s, but wimped out a bit and cut short the loading when I saw how Berkshire handled its mandatory bank divestiture in 1980 – the spin-off.

While I did not think it terribly likely, it occurred to me that there could be a small chance that rather than directly and generously buying out those of us comprising the 40% gang, preferably with Berkshire shares, Buffett might orchestrate some less-desirable reorganization and spin-off of Blue Chip, creating and disposing of an early version of a Wesco or something. I thought it unlikely, but I also didn’t underestimate Buffett’s ingenuity and so, most unfortunately, did not bet the farm.

I shouldn’t have worried. Blue Chip holders were bought out generously with Berkshire shares in 1983, and the rest has been very pleasant history. I was then at a personal BRK high; meanwhile my two co-conspirators had hit the Berkshire lottery all over again. I don’t recall my aggregate Blue Chip cost offhand, but it translated into something like a few or several hundred dollars per BRK share when the Berkshire shares we got in the exchange were trading in the $1,000 range. In essence, our cost for the Berkshire shares we received was in the hundreds of dollars.

In 1982 Forbes came out with its first ‘Forbes 400’ list. Buffett was #92 at $250 million, his net worth consisting of his 60% of Berkshire Hathaway. This was two years after “Money Masters” and the entire financial world by then knew who he was, but there was still time to get aboard at $500.

In 1985 Berkshire bankrolled Cap Cities’ acquisition of ABC. And his 1987 investment in Salomon made him pretty much a household name and sort of an emerging national hero. The share price during that fourth quarter of 1987, with all that publicity, ranged from $2,550 to $4,270.

But let’s back up to the mid-1960’s.

Buffett has said with such frequency and conviction in recent years that the textile company was his biggest mistake that now it seems that we all subscribe to that. It was a terrible vehicle to start with back then, a terrible investment, right?

Buffett is right, by the way, it was his biggest mistake. So why would anyone back then have looked at this business and tagged along?

In 1965 what was there possibly to like about a company that earned $0.11 per share the previous year on a $20 per share market price? The Berkshire annual reports back then did not include cash flow statements, but if we took the time to painfully work through it we would see that cash flow from operations (and reduced by capex) was a bit over $6 million, or $5.50 per share in 1964. (Remember that sometimes overlooked and frequently least analyzed element of cash flow: working capital ) Berkshire had used $5 million of the $6 million to immediately buy back shares, reducing share count by almost a third, and it made those purchases at bargain levels. (By the way, I’m ignoring some liquidation proceeds that Berkshire took in, which were $1.5 million in both 1964 and 1965, and just looking at cash flow from operations).

Just for reference, at a $20 per share price in 1965, Berkshire would have had a market cap of $20 million.

The balance sheet included a little bonus. Berkshire came into 1965 with a usable $5 million tax loss carry-forward, meaning a cash flow benefit potential of $4.90 per share, almost all of which would translate to cash in 1965 and 1966. Incidentally, the 1965 annual report indicated that Berkshire had $17.56 per share in working capital alone.

If we look at only the textile operations from 1965 to 1975, we see that both reported earnings and cash flow were positive every year. Over that ’65-’75 period the textile operations threw off $29 million in cash – comprised of $13 million in earnings, $5 million in tax loss carry-forward realized as cash, and $11 million in working capital reductions. There were also substantial proceeds from liquidations that I’m not even addressing – these offset textile capex over this period.

Again, this $29 million is just the cash generation from the textile business and doesn’t include any benefit from the redeployed proceeds. Not a great return, perhaps, but better than many remember it in retrospect today.

Almost half that cash was realized in ’65-‘67, funding the purchase of National Indemnity and soon after, the bank. (As we know, National Indemnity’s future float, in turn, eventually funded the purchases of GEICO, Burlington Northern, and some other subs),

In discussing the textile business, Buffett has been fond of saying that he held onto it too long, but it was no secret at the time that he was not going to close it while his original manager, Ken Chase was there. He waited until Chase retired; if that had happen to occur earlier or later things might have been better or worse. The textile company was cash-flow positive for at least that first decade though, and fairly substantially initially.

This thought has been expressed by others so I will try not to belabor it, but we do need to understand that when Buffett talks about his textile mistake and he’s talking about being substantially better off having never purchased the business, he’s talking about ‘him’ and not necessarily ‘us’.

As has been noted, if he had used the $8 million (or whatever) cash he deployed to buy his 60% or so controlling interest in Berkshire to instead directly purchase National Indemnity (without us, his partners tagging along) he wouldn’t have had the cash to purchase the bank and maybe some other things, but he could have had almost the entire Berkshire empire he controls today except that he wouldn’t have us public partners sharing it. He could have owned the entire thing himself – private, closely held public, however he chose. But the point is he would have had 100% and not 60% (or eventually 40%, and depending on his choices of future acquisition financing).

Essentially taking on new partners – meaning all of us here (or our predecessor shareholders) with no capital contribution to the enterprise from us – back then in the 1960’s was not the best move, to put it mildly. The benefit that he got from this – some control leverage over minority shareholders, worth maybe a few million dollars at the time – turned out to be exorbitantly expensive financing for him – and a screaming bargain for us in the the 40%. It was the capitalization of the transaction that did far more damage to him than the business itself.

In 1967 he tried to cash out that group, but was largely unsuccessful. He doesn’t come right out and say directly that he believes it was a mistake to let us in to his world and he wishes now he had never done that but again, that was what his “mistake” really was. He would likely personally be worth about twice as much as he is today if he hadn’t let us in so cheaply; that’s the real lost ‘opportunity cost’ here. If he could have compelled all us other shareholders to take that $20 buy-out in 1967 he would have been so much better off. Have I beat that horse enough?

Answering another question, at one point through the years I lost some confidence and sold some shares, which of course was a huge mistake.. Buffett had just lavishly praised one of his direct reports quite publicly, and attributed characteristics that I knew first-hand this person didn’t have (I had worked with this person a couple of times in his pre-Berkshire life and let’s just say I didn’t share Buffett’s admiration.)

This was the first time I even occurred to me that something was possibly amiss, and it distressed me. I knew that even talented managers really step up their game with Buffett, and I had seen that personally in another Berkshire manager’s case where I had known the fellow pre-Berkshire and the guy really stepped up with Buffett, but this time I just thought that Buffett was inexplicably wrong. In retrospect, this episode wasn’t an indication of anything other than another instance of occasional quirkiness. And we know now that Buffett doesn’t necessarily have to bat 100% in picking individuals to stand behind. A mere speed bump in the long road, as it turned out, and not an ominous tell-tale.

So some suggestions:

Be lucky, and

Maybe help out that luck by:

- Spending your formative years in a constructive environment.
- If you are, say, twelve years old and not sure if you are sitting in the winner’s circle already, at least open your eyes.
- Have good mentors you can tag along with, an later conspire with.
- Plug in to the best sources of information available, but don’t necessarily stay with only conventional pipelines.
- Identify and learn the inefficient markets.
- Perhaps pretend that we are back in the days when brokerage statements did not have dollar extensions.
- In this case, don't sweat the occasional eccentricities you observe (maybe)
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