In this market, investors will need the margin of safety that a low price brings.
The crash was just the end of the beginning. Now comes what could be many months of head-fakes and hopeful rallies that wind up in dead ends. You'll be Charlie Brown charging the football with head held high, only to land flat on your back.
Bear markets have three stages - "sharp down, reflexive rebound, and a drawn-out fundamental downtrend."
Where it stops, nobody knows, but a portfolio with strong defensive stocks stands a fighting chance.
http://myinvestingnotes.blogspot.com/2008/12/five-tips-for-buying-stocks-in-bad.html
Thursday 18 December 2014
Wednesday 17 December 2014
Strategy during crisis investment: Revisiting the recent 2008 bear market
FRIDAY, FEBRUARY 26, 2010
Strategy during crisis investment: Revisiting the recent 2008 bear market
Although we may not know where the bear bottom is, buying in a down market may still lead to losing money. This is definitely true. As long as the purchase is not at market bottom, it may still result in losses for the time being. This is likely to be a short-term loss but compensated by a probable long-term gain. Even if we cannot time the market perfectly, we are definitely better off to “buy low and sell high” then to “buy high and sell low”.
----
Prices fell but value intact
Presently stock prices have fallen sharply.
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Warren Buffett, the second richest man in the world who makes his fortune from stock investment, is busy buying undervalued companies. He sees the value and he also sees prices detaching away from the intrinsic values.He said: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turn up.”
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Catching a falling knife
Some may argue that buying now is like catching a falling knife. If you are not careful, you may be hurt and suffer more losses from falling stock prices.There is no doubt that we may incur short-term losses as long as we do not buy at the bottom. On the other hand, who can determine where and when is the bottom. As long as there are still unknown events or hidden problems, an apparent bottom now may not be the eventual bottom.Since we do not have all the information in the market, it is almost impossible to guess where the bottom will be.
----
In most cases, we only realise the bottom after it is over and by that time stock prices are running high with much improved market confidence. Market bottom could be there only for a short period. In most cases, market did not stay at the bottom waiting for investors. It will just move on.
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Since market moves ahead of the economy by about six months, the market bottoms out when the economy is still gloomy, news are still negative, analysts are still calling underweights and most investors are staying at the sidelines.
----
Handling something we know is definitely much easier than dealing with the unknown risks, something which hits from behind without warning.When we invest during a crisis we actually go in with our eyes open. We know it is definitely risky but we also know it could also be very profitable. If we can handle the risk, the risk-reward trade-off will be very rewarding.
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Emphasise strategies
What we need is to buy near the bottom, not right at the bottom. Investors’ frequent question now is when to buy, that is where is the bottom? Perhaps it is more intelligent to ask how much to buy now since nobody will be able to guess where is the market bottom.
----
Staggered buying is preferred over bullet purchase which is taking the risk of timing the market bottom. In staggered buying, a pre-determined amount will be set aside for investment over time, say in 10 equal portions.
One common method of staggered investment is dollar cost averaging, an investment scheme made in equal portions periodically, either by a small amount monthly or larger amount quarterly. There are also several variations of staggered investment.
----
Anyway, staggered purchase is a preferred method to avoid the anxiety of market timing and the mixed feeling of fear of further downside and worry of missing the market rebound. As long as the market is undervalued, the strategy of staggered investment ensures that investors are in and are benefiting from the undervalued market.
http://klsecounters.blogspot.com/2008/11/strategy-during-crisis-investment.html
----
Prices fell but value intact
Presently stock prices have fallen sharply.
- Banks are trading at 1x book value,
- property stocks sold at 50% discount from net asset value,
- utility stocks trading at single-digit price-earnings ratio providing an earnings yield of more than 10% net of tax and
- there are many good stocks trading at dividend yield of 2x bank interest rates.
----
Warren Buffett, the second richest man in the world who makes his fortune from stock investment, is busy buying undervalued companies. He sees the value and he also sees prices detaching away from the intrinsic values.He said: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turn up.”
----
Catching a falling knife
Some may argue that buying now is like catching a falling knife. If you are not careful, you may be hurt and suffer more losses from falling stock prices.There is no doubt that we may incur short-term losses as long as we do not buy at the bottom. On the other hand, who can determine where and when is the bottom. As long as there are still unknown events or hidden problems, an apparent bottom now may not be the eventual bottom.Since we do not have all the information in the market, it is almost impossible to guess where the bottom will be.
----
In most cases, we only realise the bottom after it is over and by that time stock prices are running high with much improved market confidence. Market bottom could be there only for a short period. In most cases, market did not stay at the bottom waiting for investors. It will just move on.
----
Since market moves ahead of the economy by about six months, the market bottoms out when the economy is still gloomy, news are still negative, analysts are still calling underweights and most investors are staying at the sidelines.
----
Handling something we know is definitely much easier than dealing with the unknown risks, something which hits from behind without warning.When we invest during a crisis we actually go in with our eyes open. We know it is definitely risky but we also know it could also be very profitable. If we can handle the risk, the risk-reward trade-off will be very rewarding.
----
Emphasise strategies
What we need is to buy near the bottom, not right at the bottom. Investors’ frequent question now is when to buy, that is where is the bottom? Perhaps it is more intelligent to ask how much to buy now since nobody will be able to guess where is the market bottom.
----
Staggered buying is preferred over bullet purchase which is taking the risk of timing the market bottom. In staggered buying, a pre-determined amount will be set aside for investment over time, say in 10 equal portions.
One common method of staggered investment is dollar cost averaging, an investment scheme made in equal portions periodically, either by a small amount monthly or larger amount quarterly. There are also several variations of staggered investment.
----
Anyway, staggered purchase is a preferred method to avoid the anxiety of market timing and the mixed feeling of fear of further downside and worry of missing the market rebound. As long as the market is undervalued, the strategy of staggered investment ensures that investors are in and are benefiting from the undervalued market.
http://klsecounters.blogspot.com/2008/11/strategy-during-crisis-investment.html
Thursday 11 December 2014
Where to put your cash? A house or a stock
Even as the stock market soars to record highs, federal regulators are announcing new, cheaper ways for cash-strapped borrowers to buy a home. With the catastrophic housing crash of the last decade still glaring through the rear view mirror, the government is again pushing home ownership as the best way to build wealth, but is it? "It would perhaps be smarter, if wealth accumulation is your goal, to rent and put money in the stock market, which has historically shown much higher returns than the housing market," said Nobel Prize-winning economist Robert Shiller at a Standard and Poor's conference last week.
Read More Case-Shiller home price index: CNBC Explains Shiller notes that the comparison between stock returns and home value returns is rough, given that stocks pay cash dividends and housing pays "in kind," in the form of housing services; that is, you get to live in a house. Still, if you remove all forms of dividends and compare the Standard and Poor's U.S. composite stock price index since 1871 and Shiller's own real U.S. home price index since 1890, the stock market capital gains outperform the housing market's capital gains. Both, he notes, are smaller than one might expect.
Read More Low down payment mortgages back for buyers "The real S&P composite has increased 12.2-fold from January 1890 to December 2014, or 2.03 percent per year, much less than most people would have guessed. Most of the real return in the stock market over the last century has come from dividends, not real capital gains," said Shiller. "Home prices have increased only 1.5-fold, or only 33 basis points a year. Essentially, home price capital gains overall have amounted to virtually nothing." One must also account for the costs of home ownership, costs that don't exist in stock ownership. Property taxes, insurance, maintenance, renovation all subtract from the capital gains of owning a home.
Read More The top 10 housing markets for growth in 2015 The downside to stocks, however, is capital gains taxes.
"If we had much stronger 401K [retirement]-type programs in the United States, much more heavily pushed, much bigger commitment from everybody, would that replace homeownership as a way to build wealth?" asked David Blitzer, chairman and managing director at S&P Dow Jones Indices. "Right now my impression is that the tax benefits of a 401(k) plan or other contribution pension plans pale compared to home ownership." The Case Shiller home price index (red) versus the S&P 500 Index (blue) since 1987. Source: S&P Dow Jones Indices A house can offer greater returns if the owner chooses to rent it out and not to live in it; however the consumption value of the home to the owner, again that value of actually inhabiting it, is gone. And that adds to Shiller's point that a home should not be seen as an investment vehicle, like a stock, but as a consumption good, like a car.
Read More Jumbo mortgage: CNBC Explains "You don't accrue as much wealth as a renter as you do as a buyer," noted Sam Khater, deputy chief economist of CoreLogic. "The con, though, is that with home ownership being the primary way that the middle class gets richer over time, and with the bulk of their wealth and equity tied up in housing, if home prices decline, they take a huge hit." The happy compromise, it seems, would be to keep less equity in your home, through a long-term, low-down payment mortgage, or, if you can qualify, through an interest-only loan, and keep more cash ready for investing in the stock market.
Read More Self-employed? Good luck getting a mortgage It's a riskier choice, given the current volatility in home prices, but it may be the best way to build wealth.
https://my.news.yahoo.com/where-put-cash-house-stock-181236282.html
Friday 5 December 2014
Don't just sit there, invest!
Foolish takeaway
To be scared out of the market - or to not start investing - because of periods of market uncertainty, volatility or even steep declines, has been a very expensive mistake.
Ignore market fluctuations. Buy great companies at good prices.
It's an approach that has stood the test of time - and made small fortunes for those who follow that path.
Read more: http://www.smh.com.au/business/motley-fool/dont-just-sit-there-invest-20141128-11w2cy.html#ixzz3L1X4ccRv
Tuesday 4 November 2014
Friday 24 October 2014
Tesco: Expect full-year adjusted earnings per share (EPS) of 15.15p and about the same in 2015, says Deutsche.
Deutsche Bank has cut estimates for the second-half and for the full-year. The broker now expects full-year UK profit of £814 million, 23% less than previous estimates, and 13% less in Asia, driving annual group profit down 45% to £1.8 billion. In 2011, it was almost £4 billion. Expect full-year adjusted earnings per share (EPS) of 15.15p and about the same in 2015, says Deutsche.
At 174p, Tesco shares trade on 11.5 times forward earnings. That’s expensive given the ongoing price war will likely continue to crush UK margins, and without any guidance either on profits, or strategy. Much will be expected from the January statement. Until then, it’s difficult to see any positive catalysts.
http://www.iii.co.uk/articles/200463/tesco-horror-show-continues
http://www.iii.co.uk/tv/episode/tesco-fiasco-dissected
At 174p, Tesco shares trade on 11.5 times forward earnings. That’s expensive given the ongoing price war will likely continue to crush UK margins, and without any guidance either on profits, or strategy. Much will be expected from the January statement. Until then, it’s difficult to see any positive catalysts.
http://www.iii.co.uk/articles/200463/tesco-horror-show-continues
http://www.iii.co.uk/tv/episode/tesco-fiasco-dissected
Wednesday 22 October 2014
Thursday 16 October 2014
What is capitulation?
What is capitulation? CNBC Explains
Traditionally, the word capitulation describes a surrender between fighting armies. What is capitulation when it's used on Wall Street? What does it signify? We explain.
What is capitulation?
In simple terms, capitulation is when investors try to get out of the stock market as quickly as possibleand look for less risky investments. It's also described as panic selling. It's usually based on investor fears that stock prices will fall further than they have.
Capitulation is usually signaled by a decline in the markets of at least 10% in one day.
In getting out of the market, investors give up any previous gains in stock price. That means they take a financial loss, just to get out of stocks. The thinking is: take a smaller loss now rather than a bigger one later.
Real capitulation involves extremely high volume-or high numbers of traded shares-and sharp declines in stock prices.
Why do investors capitulate?
Suppose a stock starts dropping in price. There are two choices. Investors stick it out and hope the stock begins to appreciate-or they can take the loss by selling the stock.
If the majority of investors decide to wait it out, then the stock price will probably remain stable. But if the majority of investors decide to capitulate and give up on a stock, they start selling and that starts a sharp decline in a stock's price.
Are there any benefits from capitulation?
Only for those buyers ready to swoop in. After capitulation selling, common wisdom has it that there are great bargains to be had in the stock market. Why? Because everyone who wants to get out of a stock, for any reason, has sold it. The price should then, theoretically, reverse or bounce off the lowest price of the stock.
In other words, some investors believe that capitulation is the sign of a bottom and a chance to get stocks at a cheaper price than before the capitulation took place.
Is capitulation a way to gauge the markets?
Not at all.Capitulation is very difficult to forecast and use as a way to buy or sell stocks. There is no magical price at which capitulation takes place. Certainly during the trading day, stock prices and volumes are monitored and some measurement is used to determine if a capitulation is taking place and will remain so at the end of the day.
But most often, investors and market watchers look back to determine when the markets actually capitulated and see how far stocks have fallen in price for that one day of trading.
When have there been capitulations?
The stock market crash of 1929 that helped lead to the Great Depression, is a capitulation. In fact, it had more than one day of it.
On Oct. 24, 1929-what's known as Black Thursday-share prices on the New York Stock Exchange collapsed. A then-record number of 12.9 million shares was traded.
But more was to follow. Oct. 28, the first "Black Monday," more investors decided to get out of the market, and the slide continued with a record loss in the Dow for the day of 38 points, or 13 percent.
The next day, "Black Tuesday," Oct. 29, 1929, about 16 million shares were traded, and the Dow lost an additional 30 points.
More recently, there was a massive sell off or panic selling of stocks on Oct. 10, 2008, in what can be considered a capitulation. Not only U.S. stocks, but global markets had major declines of 10 percent or more on one day.
Investors flooded exchanges with sell orders, dragging all benchmarks sharply lower. It's believed fears of a global recession and the U.S. housing slump sparked the sell-off.
Traditionally, the word capitulation describes a surrender between fighting armies. What is capitulation when it's used on Wall Street? What does it signify? We explain.
What is capitulation?
In simple terms, capitulation is when investors try to get out of the stock market as quickly as possibleand look for less risky investments. It's also described as panic selling. It's usually based on investor fears that stock prices will fall further than they have.
Capitulation is usually signaled by a decline in the markets of at least 10% in one day.
In getting out of the market, investors give up any previous gains in stock price. That means they take a financial loss, just to get out of stocks. The thinking is: take a smaller loss now rather than a bigger one later.
Real capitulation involves extremely high volume-or high numbers of traded shares-and sharp declines in stock prices.
Why do investors capitulate?
Suppose a stock starts dropping in price. There are two choices. Investors stick it out and hope the stock begins to appreciate-or they can take the loss by selling the stock.
If the majority of investors decide to wait it out, then the stock price will probably remain stable. But if the majority of investors decide to capitulate and give up on a stock, they start selling and that starts a sharp decline in a stock's price.
Are there any benefits from capitulation?
Only for those buyers ready to swoop in. After capitulation selling, common wisdom has it that there are great bargains to be had in the stock market. Why? Because everyone who wants to get out of a stock, for any reason, has sold it. The price should then, theoretically, reverse or bounce off the lowest price of the stock.
In other words, some investors believe that capitulation is the sign of a bottom and a chance to get stocks at a cheaper price than before the capitulation took place.
Is capitulation a way to gauge the markets?
Not at all.Capitulation is very difficult to forecast and use as a way to buy or sell stocks. There is no magical price at which capitulation takes place. Certainly during the trading day, stock prices and volumes are monitored and some measurement is used to determine if a capitulation is taking place and will remain so at the end of the day.
But most often, investors and market watchers look back to determine when the markets actually capitulated and see how far stocks have fallen in price for that one day of trading.
When have there been capitulations?
The stock market crash of 1929 that helped lead to the Great Depression, is a capitulation. In fact, it had more than one day of it.
On Oct. 24, 1929-what's known as Black Thursday-share prices on the New York Stock Exchange collapsed. A then-record number of 12.9 million shares was traded.
But more was to follow. Oct. 28, the first "Black Monday," more investors decided to get out of the market, and the slide continued with a record loss in the Dow for the day of 38 points, or 13 percent.
The next day, "Black Tuesday," Oct. 29, 1929, about 16 million shares were traded, and the Dow lost an additional 30 points.
More recently, there was a massive sell off or panic selling of stocks on Oct. 10, 2008, in what can be considered a capitulation. Not only U.S. stocks, but global markets had major declines of 10 percent or more on one day.
Investors flooded exchanges with sell orders, dragging all benchmarks sharply lower. It's believed fears of a global recession and the U.S. housing slump sparked the sell-off.
Sunday 12 October 2014
Slow and steady doesn't make headlines, but the company can continue to earn excellent returns on invested capital.
CTB operates worldwide in the agriculture equipment field. Berkshire purchased it in 2002 and by 2009, it has picked up six small firms.
Berkshire paid $140 million for the company. In 2008, its pre-tax earnings were $89 million.
Vic Mancinellis, CEO of CTB, an agricultural equipment company, one of Berkshire's boring manufacturing businesses, exemplifies another reason for optimism.
Since Buffett bought CTB in 2002, it has earned roughly an average 11 percent annual return, compared to the S&P return of only 3 percent.
How can such a basic business produce eye-popping results?
It wasn't through financial innovations or game-changing acquisitions. Instead, Mancinelli focussed on "blocking and tackling, day by day doing the little things right and never getting off course:"
Ten years from now, Vic will be running a much larger operation and, more important, will be earning excellent returns on invested capital.
But slow and steady doesn't make headlines. Investors approaching the stock market continue to put their money in the hare, not the tortoise.
Betting on tortoises can create long-lasting wealth.
Berkshire paid $140 million for the company. In 2008, its pre-tax earnings were $89 million.
Vic Mancinellis, CEO of CTB, an agricultural equipment company, one of Berkshire's boring manufacturing businesses, exemplifies another reason for optimism.
Since Buffett bought CTB in 2002, it has earned roughly an average 11 percent annual return, compared to the S&P return of only 3 percent.
How can such a basic business produce eye-popping results?
It wasn't through financial innovations or game-changing acquisitions. Instead, Mancinelli focussed on "blocking and tackling, day by day doing the little things right and never getting off course:"
Ten years from now, Vic will be running a much larger operation and, more important, will be earning excellent returns on invested capital.
But slow and steady doesn't make headlines. Investors approaching the stock market continue to put their money in the hare, not the tortoise.
Betting on tortoises can create long-lasting wealth.
Goodwill. Understand the "cost" of goodwill.
Goodwill is an accounting term that describes the dollars paid to buy a business over and above its book value. Goodwill is a real number, but it tells us nothing about the future earning power of a business.
Berkshire owns some terrific businesses. Many of them were purchased, however, at large premiums to net worth - point reflected in the good will item shown in its balance sheet. In year 2008, its balance sheet reported a goodwill of US 16,515 millions. The company earned an impressive 17.9% on average tangible net worth in 2008, but if goodwill was included, this reduced the earnings to 8.1%.
Buffett paid more for these businesses because he expects them to earn gobs of money in the future. In this happy event, the goodwill number is not relevant.
However, if increased earnings don't materialize, the amount of goodwill will weigh on the earnings of a business. How will this affect investor returns?
By including the amount paid for goodwill in the return calculation, Buffett clearly reports the "cost" of goodwill.
In 2008, Berkshire investors got a return of only 8.1% on their total net worth, including goodwill, compared to a return of 17.9% on tangible net worth, excluding goodwill.
Most large U.S. companies have large amounts of goodwill reported on their balance sheets. This information is important to know. If companies pay more for acquisitions than the future earnings these ventures produce, investors will be harmed.
Berkshire owns some terrific businesses. Many of them were purchased, however, at large premiums to net worth - point reflected in the good will item shown in its balance sheet. In year 2008, its balance sheet reported a goodwill of US 16,515 millions. The company earned an impressive 17.9% on average tangible net worth in 2008, but if goodwill was included, this reduced the earnings to 8.1%.
Buffett paid more for these businesses because he expects them to earn gobs of money in the future. In this happy event, the goodwill number is not relevant.
However, if increased earnings don't materialize, the amount of goodwill will weigh on the earnings of a business. How will this affect investor returns?
By including the amount paid for goodwill in the return calculation, Buffett clearly reports the "cost" of goodwill.
In 2008, Berkshire investors got a return of only 8.1% on their total net worth, including goodwill, compared to a return of 17.9% on tangible net worth, excluding goodwill.
Most large U.S. companies have large amounts of goodwill reported on their balance sheets. This information is important to know. If companies pay more for acquisitions than the future earnings these ventures produce, investors will be harmed.
Saturday 11 October 2014
Ignore the noises that rattle the markets. A conclusion about the economy does not tell us if the stock market will rise or fall.
In 75% of those years (from 1965 to 2008), the S&P stocks recorded a gain. You can guess that a roughly similar percentage of years will be positive in the future too.Can you predict the winning and losing years in advance? I don't think anyone can.
The economy was in shambles throughout 2009, but that did not tell us whether the stock market will rise or fall.
A conclusion about the economy does not tell us if the stock market will rise or fall.
The economy was in shambles throughout 2009, but that did not tell us whether the stock market will rise or fall.
A conclusion about the economy does not tell us if the stock market will rise or fall.
Understand accounting allows you to understand how companies create value.
To better understand the wealth-producing advantages of the businesses, you have to understand accounting and the "vastly different" financial reporting characteristics of various businesses.
Accounting, just like eating spinach, may not be what you want, but it sure is good for you. :-)
A little patience brings great rewards. You can learn something important about each business and can also use your knowledge to understand how other companies create value.
You want to be informed, confident and loyal in your investing.
Accounting, just like eating spinach, may not be what you want, but it sure is good for you. :-)
A little patience brings great rewards. You can learn something important about each business and can also use your knowledge to understand how other companies create value.
You want to be informed, confident and loyal in your investing.
Buffett: See's Candies - A Great, Not Just a Good, Business
Buffet never forgets that growth is good, but only at a reasonable cost.
In 2007, See's Candies sold 31 million pounds of chocolate, a growth rate of only 2 percent. What does Buffett see that other misses?
1. He paid a sensible price for the business.
2. The company enjoys a durable competitive advantage: Its quality chocolate is bought by legions of loyal customers.
3. It is a business he understands.
4. It has great managers.
But See's Candies possesses one more attraction. It throws off cash and requires very little capital to grow.
Here is Buffett explaining See's value proposition in his 2007 shareholder letter:
" We bought See's [in 1972] for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.
Last year See's sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth - and somewhat immodest financial growth - of the business. In the meantime pre-tax earnings have totalled $1.35 billion. all of that, except for the $32 million, has been sent to Berkshire."
Buffett uses See's cash to buy other attractive businesses.
"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us. (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.) .. There's no rule that you have to invest money where you've earned it. Indeed, it's often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."
But a company like slow-growing See's is rare in corporate America. In order to grow earnings like See's, CEOs in other businesses typically would need "to invest $400 million, not the $32 million" that See's required. Why is this true? Because most growing businesses "have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments." Not so at See's.
Buffett opines that the great business, like See's, is like a savings account that "pays an extraordinarily high interest rate that will rise as the years pass."
See's is not just the candy. To Buffett, the company is a chocolate-powered cash machine.
Additional notes: Great, Good and Gruesome Businesses of Buffett
Capital Allocation and Savings Accounts
Buffett compares his three different types of great, good and gruesome businesses to "savings accounts."
The great business is like an account that pays an extraordinarily high interest rate that will rise as the years pass.
A good one pays an attractive rate of interest that will be earned also on deposits that are added.
The gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.
In 2007, See's Candies sold 31 million pounds of chocolate, a growth rate of only 2 percent. What does Buffett see that other misses?
1. He paid a sensible price for the business.
2. The company enjoys a durable competitive advantage: Its quality chocolate is bought by legions of loyal customers.
3. It is a business he understands.
4. It has great managers.
But See's Candies possesses one more attraction. It throws off cash and requires very little capital to grow.
Here is Buffett explaining See's value proposition in his 2007 shareholder letter:
" We bought See's [in 1972] for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.
Last year See's sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth - and somewhat immodest financial growth - of the business. In the meantime pre-tax earnings have totalled $1.35 billion. all of that, except for the $32 million, has been sent to Berkshire."
Buffett uses See's cash to buy other attractive businesses.
"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us. (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.) .. There's no rule that you have to invest money where you've earned it. Indeed, it's often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."
But a company like slow-growing See's is rare in corporate America. In order to grow earnings like See's, CEOs in other businesses typically would need "to invest $400 million, not the $32 million" that See's required. Why is this true? Because most growing businesses "have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments." Not so at See's.
Buffett opines that the great business, like See's, is like a savings account that "pays an extraordinarily high interest rate that will rise as the years pass."
See's is not just the candy. To Buffett, the company is a chocolate-powered cash machine.
Additional notes: Great, Good and Gruesome Businesses of Buffett
Capital Allocation and Savings Accounts
Buffett compares his three different types of great, good and gruesome businesses to "savings accounts."
The great business is like an account that pays an extraordinarily high interest rate that will rise as the years pass.
A good one pays an attractive rate of interest that will be earned also on deposits that are added.
The gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.
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