Essentials of Value Investing

The Intelligent Investor by Benjamin Graham and Greenwald’s Book: Value Investing from Graham to Buffett and Beyond.

Class Case Studies

This is a class in a specific kind of investing. There are two basic approaches. There are short-term  investors (preferably not investing taxable money). Many technical investors who do not care about the underlying quality of the companies invest solely on price information. Although some value investors build a time element into their investments. There are investors who look at short-term earnings. Analysts spend their time on earnings’ forecasting. If you think IBM is going to do $1.44  vs. the analyst estimates of $1.40, then you buy IBM, because analysts are behind the real growth in earnings. Your estimate is correct.

Another group, who has given up altogether, they believe the markets are efficient; they index.  Unless the distribution is very skewed, then only 50% of the investors can outperform the market. This is a market for long-term investors with a particular orientation (value investors). You look at a security and it  will represent a claim on earnings and assets. What is that claim worth? If you think that a company is worth $22 to $24 per share, then you look to buy with a margin of  safety. When the margin of safety is sufficiently large, you will buy. You will look for bargains.

Value Investors constitute only 7% of the investor universe. There is substantial statistical evidence that value investing works: higher returns with lower risks than the market.


Value Investing (“VI”) rests on three key characteristics of financial markets:

1. Prices are subject to significant and capricious movements that can temporarily cause price to diverge from intrinsic value. Mr. Market is to offer you various prices, not to guide you.  Emotionalism and short-term thinking rule market prices in the short-run.

2. Financial assets do have underlying or fundamental economic values that are relatively stable and can be measured by a diligent and disciplined investor. Price and value often diverge.

3. A strategy of buying when prices are 33% to 50% below the calculated intrinsic value will produce superior returns in the long-run. The size of the gap between price and value is the "margin of safety

We put someone (into business with a value formula that has averaged 20% plus returns over the past four years. He will be on the show, Imposter!

The preponderance of evidence is overwhelming for value investing as a good approach.
1. Statistical evidence
2. Performance evidence of big value funds (Oakmark, Third Avenue, Fairholme, Tweedy Browne)
3. Relatively episodic evidence that a disproportionately large amount or percentage of successful investors follow the value approach.

All human beings have certain predispositions that hurt themselves and prevent them from following 
the value approach.

Essentials of Value Investing

Long-term - Fundamental (Look at Underlying Businesses)

Specific Premises

(1) Mr. Market is a strange guy - prices diverge regularly from fundamental values

(2) You can buy under priced Stocks - fundamental values are often measurable

(3) Fundamental value determines future price - Buying under priced stocks plus patience implies superior returns.

Patience helps create time arbitrage between short term focus and long-term values.

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Why Value Investing works. Buying cheaply works.

WHY VALUE INVESTING WORKS

Markets are not Efficient
All you should worry about since you aren’t going to be able to outguess the market is minimizing transaction costs, and allocating assets that creates an appropriate risk profile. What I think you ought to know about that is two things.

• The first is that there is overwhelming statistical evidence that markets are not efficient. In all countries and all periods of time since the early 20th century, that there are variables that can be reliably used to outperform the market and that clearly contradicts the premise that nobody can outperform the market. 
• There is a sense in which absolutely and fundamentally markets are efficient and it is this—that when we buy as night follows the day someone else is selling that stock thinking it is going down--and one of you is always wrong. (Don’t play the patsy!)

Why Are You on the Right Side of the Trade?
Another way of saying that is not everybody can outperform the market. The famous humorist called Garrison Keiller talks about a fictional town called Lake Woebegone. In Lake Woebegone all the women are beautiful, all the men are tall and all the children are above average. In this game all the children are average on average which means half of them underperforms the market. So when you start to think about investing, you must be able to answer the question:

• Why are you able to beon the right side of the particular trade? 
• Why are you the one who is right, and the person who is trading with you is wrong? That is the most fundamental aspect of Investing. 
• Where and what is your investing edge? 
• What puts you on the right side of the trade?

Buying Cheaply Works
When we talk about value investing there is a lot of evidence that value investors have been on the
right side of the trade. 

• The statistical studies that run against or contradict market efficiency almost all of them show that cheap portfolios—low market-to-book, low price-to-book—outperform the markets by significant amounts in all periods in all countries—that is a statistical, historical basis for believing that this is one of the approaches where people are predominantly on the right side of the trade.  And, of course, someone else has to be on the wrong side of the trade.
• Those studies were first done in the early 1930s; they were done again in the early 1950s. And the ones done in the 1990s got all the attention because the academics caught on. There is statistical evidence that the value approaches—buy cheap securities—have historically outperformed the market.  Buying Cheap works.

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Value Investing in Practice: Search strategy, Valuation strategy and Patience

Value Investing in Practice

Long-term - Fundamental (look at underlying business)

(1) Look intelligently for value opportunities (Low P/E, M/B)
o Mr. Market is not crazy about everything
o This is the first step not to be confused with Value Investing

(2) Know what you know
 Not all value is measurable
 Not all value is measurable by YOU (Circle of Competence)

(3) You don't have to swing    PATIENCE

Value Investing: the Approach

Search (Look Systemically for under valuation) -->Value --> Review --> Manage Risk 

 Value implies concentration not diversification. (Look for a Margin of Safety)

 At worst Buy the Market)

----------


1.  SEARCH STRATEGY

Look intelligently for value opportunities. You must have search strategies. Every time you sell stock, someone else is buying that security. Vast majority—95%--is selling because the stock will go down versus buying because the stock is going up. You seek a seller that is motivated by psychological imperatives other than the underlying value. One person on one side of the trade is always wrong. 

Trust me--that will be the case (with you) in big tech stocks that are covered by 100s of analysts. YOU have no advantage or edge.

Where will I look for opportunities? Where I will be the smart one on the side of this trade? You have to decide what type of investing you want to do in this realm. In every case, they pursue in concentrated fashion a particular niche strategy or specialty within the value area.

You have to know what you know and what you don’t know.

 Not all value is measurable *
 Not all value is measurable by you.
 Where do I have the advantage?
 Where am I the smart money? *

* Critical for one to determine

Great investors focus on specific opportunities in concentrated ways. They are very disciplined by staying within their circle of competence.

I (Bruce C. Greenwald) used to sit on panels of money managers who managed foundations' money. Some money managers would say that they are close to MSFT and we know what it will do. Thank God I am not that stupid. MSFT is impossible to value. Much of the value is in the future of the future (think of the large amount of estimation in the terminal value of Disc. Cash Flow). 85% of the value of MSFT will come in the years 2010 to 2020!

How much of the investment in 2000 you get back by 2010—15%. The other 85% value of MSFT is beyond 2010—(2010-2020)! Lots of luck. No one can do that. Then they say they can do it for complicated companies like Citicorp and GE? Forget it.

Understand what valuations are fundamentally impossible. Stay away from those glamour stocks.

If you try to be an expert in everything, you will be an expert in nothing. You can specialize in small stocks, highly complicated situations, or a specific industry or country.

When you say you know what it is worth, you better know better than the rest of the investors in the community.


2. VALUATION STRATEGY

You want an approach, a valuation procedure and a discipline that will restrict you to making decision on the basis of what you really know. You are betting against the person on the other side of your trade. Where is your edge?


3. PATIENCE

You have to be patient. Mr. Market throws a pitch every day, but you only have to swing at the ones that are in your sweet spot. THE FAT PITCH IN YOUR STRIKE ZONE.

Patience is rewarded especially when you are on the other side of impatient money.

The BAD NEWS:

They run up the score whether you swing or not, and you are being judged by the other scores. You are being judged relative to the market.

What is your default strategy when there is nothing to do? Buy the market in an index fund vs. cash. What does the absence of opportunity tell you?

If you think DCF is the best way to value companies, then you will have a problem.

In practice, you want to look intelligently for value opportunities, a valuation strategy that identifies what you really know, and you want an appropriate default strategy for managing risk.

All the elements have to be in place. Valuation strategy must be appropriate to your search strategy. You always have to track what you do. Have you lost money on this type of stock before? If you have made a mistake before, be aware of it. Be aware of the market and what other intelligent investors are doing. If you think Wells Fargo is overvalued, you want to think carefully about selling if Warren Buffett is on the other side.

Reviewing these judgments.

How do you manage risk? How do you put together a portfolio? A more concentrated portfolio requires better patience and valuation. Think about the underlying economic reality.

In general, stocks have outperformed all other assets. Default strategies and investing in indexes and having a balanced strategies. One value investor said cash was better than an index strategy. Test: Read through great value investors' letters when they have mostly cash vs. having the money in an index over the next three years, the results were so discouraging to his hypothesis. The index outperforms cash.

In 1986, Bill Ruane went into cash and thought the market was over-valued. Think of an equity bias.

Another lesson, you can hedge out the risk of the stock market as a whole at a low price. Historically, that has not been a good strategy. Look at the market as a whole and it would influence your allocation between cash and an index.


Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

OPPORTUNITIES IN VALUE INVESTING

OPPORTUNITIES IN VALUE INVESTING

1.  Prices and Intrinsic Values Regularly Diverge

• If prices are fluctuating a lot and you think fundamental values are stable and the evidence is in favor of that too. Then Prices are going to diverge regularly from fundamental value.

2.  You Can Measure Some Fundamental Values

The second assumption is more problematical: it is that you can identify which stocks are trading above or below their fundamental values.

• That means fundamental values have to be measurable and that is by no means always the case especially by you. 
• To give you a simple example of that, I sit on panels where we advise the managers of charitable trusts who invest money in the United States and invariably it is me and a bunch of people who sell money management services,and they all talk about how good they are at evaluating or estimating the value of stocks like Microsoft. And this was back when Microsoft was trading at 70 times earnings when it was at $110 a share. This was in the year 2000.And I thought, thank God I am not that type of Jackass who has to pretend to be able to do that. 
• Because the truth of the matter is that the value of Microsoft doesn’t depend upon what happens in the next ten years because the dividend return you will get will be at most 15% of the value of the stock. 
• So what you are pretending what you can do is being able to forecast what MSFT will look like in the year 2010 and from then on. If you do that, lots of luck. So it is not clear, but we are going to talk about cases where it is true and where you can do it. 

Price and Values will Converge

Then another article of faith is ultimately the fundamental values will out. If you hold it long enough, you will get superior returns and the market prices of these stocks will return, and there is some evidence that is the case.

• When you try to put this into practice, what it means is first of all, because most, not all, will not be strikingly under or overvalued if you are thinking of going short. 
• You have to look Intelligently for things that you are going to value. 
• Then when you estimate values, you have to be rigorous about knowing what you know. 

Not all values are measurable (as in the Microsoft case.)

• And much more importantly as Warren Buffett has recently proved—though he is the most successful investor in history, but as he has recently proved with respect to silver and the value of the dollar--not everybody is an expert in everything. 
• You are not going to be good at valuing everything. 
• You have to concentrate on what your own particular circle of competence is. 

3.  Search for Opportunities

The third idea is that you look Intelligently for opportunities.

• You are rigorous about valuing those opportunities and then you have to be patient. 
• And Buffett tells a little story where he says, ― Investing is not like baseball where you have to swing at every pitch. You don’t have to swing, they can throw as many pitches as you want, and you still don’t have to swing. 
• Value investing implies concentration not diversification. 
• Because you can be patient, you want to wait for your pitch. 
• That is the good news. 

The bad news is that any professional investor knows--they run up the score whether you swing or not. 

• Because you are being compared to indices. 
• Because you have to have some reasonable strategy for what you are going to do when there is no obvious opportunity in these two categories. 

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School
Edited by John Chew at Aldridge56@aol.com studying/teaching/investing Page 7

Where do you always want to start a valuation?

STARTING A VALUATION 

Asset Valuation 

Where do you always want to start a valuation?  You want to start with assets.  Why?  Because they are tangible.  You could technically go out and look at everything that is on the firm’s balance sheet. Even the intangibles like the product portfolio you could investigate it today without making any projections or extrapolations.  You could even investigate the quality of things like the trained labor force and the quality of their business relationships with their customers (I think this is very difficult to ascertain). 

Start with that. It is also your most reliable information. It is also all that is going to be there if this is not a viable industry, because if this is not a viable industry, this company is going to get liquidated.  And what you are going to see is the valuation in liquidation. And that is very closely tied to the assets.   In that case, with that strategic assumption, you are going to go down that balance sheet and see what is recoverable.  But suppose the industry is viable, suppose it is not going to die. How do you value the assets then? Well, if the industry is viable then sooner or later the assets are going to be replaced so you have to look at the cost of reproducing those assets as efficiently as possible.   So what you are going to do is you are going to look at the reproduction value of the assets in a case where it is a viable industry.  And that is where you are going to start. We will go in a second and a little more tomorrow about the mechanics of doing that reproduction asset valuation. But that is value that you know is there.  


Earnings Power Valuation

The second thing you are going to look at because it is the second most reliable information you are going to look at is the current earnings. Just the earnings that you see today or that are reasonably forecastable as the average sustainable earnings represented by the company as it stands there today.   

And then we are going to extrapolate.  We are going to say suppose there was no growth and no change what would the value of those earnings be? Let’s not get into the unreliable elements of growth. Let’s look secondly at the earnings that are there and see what value there is. And that is the second number you are going to calculate and the likely market value of this company.  But it turns out that those two numbers are going to tell you a lot about the strategic reality and the likely market value of this company.  

Illustration

Suppose this is a commodity business like Allied Chemical and you have looked at the cost of reproducing the assets.  And you think you have done a pretty good job at that—And you could build or add buildings, plants, cash, accounts receivables and inventory that represents this business-- customer relationships, a product line--for a billion dollars.  This is usually going to be the cost for their most efficient competitors, who are the other chemical companies.  So the cost of reproducing this company is a billion dollars. Suppose on the other hand its earnings power is $200 million, and its cost of capital is 10% so the value of it s earnings which mimics its market value is two billion dollars ($200 million/0.10).  What is going to happen in that case?  Is that  two billion $ going to be sustainable?   $2 billion in earnings power value (EPV) is double the asset value (AV) of the company but there are no sustainable competitive advantages. If EPV is > than AV, then sustainability depends upon franchise value (“FV”). 

Well, think about what is going on in the executive suites of all these chemical companies. They are going to seed projects where they can invest $1 billion dollars and create two billion dollars of value.  What these guys love better than their families are chemical plants.  So you know those chemical plants are going to get built if there is not something to prevent that process of entry.


Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School 
Edited by John Chew at Aldridge56@aol.com                           
studying/teaching/investing Page 24 


Additional notes:

Reversion to the Mean or the Uniformity of One Price 

As the chemical plants get built, what is going to happen to this chemical price?  It is going to go down. The margins will decline, the earnings power value and the market value of the company will go down. Suppose it goes down to a $1.5 billion.  Will that stop the process of entry?  No, not at all. Because the opportunity will still be there.  (Profits still above the cost of capital) 

In theory, the process of entry should stop when the cost of reproducing those assets equal the market value of those assets.  In practice, of course, it is easier to buy a puppy than to drown it later.  Once those puppies are bought, you are stuck with it.  The process of exit is slower than entry.   The same thing applies to chemical plants.  Once those chemical plants are built, they are likely to stay there for a long time.  Typically, the process may not stop there.  It applies equally to differentiated products. Suppose Ford, to reproduce their assets of the Lincoln division is $5 billion and the earnings power value and the market value is 8 billion. What is going to happen then?  Mercedes, the Europeans and the Japanese are going to look at that opportunity, and they are going to enter. 

Now do prices necessarily fall?  No, not in this case, they match Ford’s price. What will happen to Ford’s sales?  Inevitably they are going to go down because they will lose sales to the entrants.  What therefore will happen to their unit fixed costs?  The costs will rise.  Their variable costs are not going down, so their unit costs are going up.  The prices are staying the same, their margins are going down and their per units sold and their sales are going down, so what happens to profits here with a differentiated market and with a differentiated product?  Exactly the same thing.  

The differentiated products won’t save you. And that will go on until the profit opportunity disappears.  Unless there is something to interfere with this process of entry, sooner or later the market value of the company will be driven down to the reproduction value of the assets.  Especially, in the case of the Internet. You had companies that didn’t have any earnings that were $5, $10 or $15 billion dollars whose assets could be reproduced for $10 million or $15 million dollars.  Unless there is something to stop the process of entry, the earnings to support that are not going to materialize.  So what you are looking at is a decline.

Asset value (AV) and Earnings power value (EPV). Know the 3 scenarios - AV > EPV, AV = EPV and AV < EPV

What you have got then is two pictures of value: 

1. You have got an asset value
 2. You have got an earnings power value
 
And now you are ready to do a serious analysis of value. If the picture looks like case A (AV > EPV), what is going on assuming, you have done the right valuation here? If it is an industry in decline, make sure you haven’t done a reproduction value when you should be doing a liquidation value.  What it means is say you have $4 billion in assets here that is producing an equivalent earnings power value of $2 billion. What is going there if that in the situation you see?  It has got to be bad management.  Management is using those assets in a way that can not generate a comparable level of distributable earnings.  

AV is Greater Than EPV 

• In this case the critical issue—it would be nice if you could buy the company—but typically you pay the reduced EPV and all that AV is sitting there.
• Then you are going to be spending your time reading the proxies and concentrating on the stability or hopefully the lack of stability of management. 
• Preeminently in that situation, the issue is a management issue. 
• The nice thing about the valuation approach is that it tells you the current cost that management is imposing in terms of lost value.  That is not something that is revealed by a DCF analysis. And there are a whole class of value investments like that.
• One of the great contributions to the theory of this business is Mario Gabelli’s idea that really what you want to look for in this case is a catalyst that will surface the true asset value.
• You can wait and sometimes that catalyst may be Michael Price or Mario Gabelli if they own enough of the company.  I would like to encourage those investors who are big enough to make that catalyst you.  

AV Equals EPV 

• The second situation where the AV, the reproduction value of the assets = EPV are essentially the same.
• That tells a story like any income statement or balance sheet tells a story.  It tells a story of an industry that is in balance.  
• It is exactly what you would expect to see if there were no barriers-to- entry. 
• And if you look at this picture and then you analyze the nature of the industry—if you say, for example, this is the rag trade and I know there are no competitive advantages—you now have two good observations on the value of that company. 
• If it ever were to sell at a market price down here, you know that is what you would be getting. You are getting a bargain from two perspectives: both from AV & EPV so buy it. 

EPV in Excess of AV 

• We have ignored the growth, but I will talk about it in a second#. The last case is the one we really first talked about. You have got EPV in excess of AV. 
• The critical issue there is, especially if you are buying the EPV—is that EPV sustainable?
• That requires an effective analysis of how to think about competitive advantages in the industry.

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School 
Edited by John Chew at Aldridge56@aol.com                           
studying/teaching/investing Page 26

 Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf



Related topic: #
Look at growth from the perspective of investment required to support the growth. Profitable Growth Occurs Only Within a Franchise.

Two pictures of value: An asset value and an earnings power value.

Mechanically Doing a Valuation 

1.  Doing an asset valuation

Now, doing an asset valuation is just a matter of working down the balance sheet. 

• As you go through the balance sheet, you ask yourself what it costs to reproduce the various assets.
• Then for the intangibles list them like the product portfolio and ask what will be the cost reproducing that product portfolio. 

2.  Doing an Earnings power valuation

For the EPV, you basically have to calculate two things:  

• You have to calculate earnings power which is the current earnings that is adjusted in a variety of ways.
• You divide the normal earnings by the cost of capital.

There is an assumption in an earnings power value and part of it is being careful about what earnings are.  This is just a picture of what some of those adjustments look like.

• You have to adjust for any accounting shenanigans that are going on, you have to adjust for the cyclical situation, for the tax situation that may be short-lived, for excess depreciation over the cost of maintenance capital expense (MCX).
• And really for anything else that is going on that is causing current earnings to deviate from long run sustainable earnings.
• So valuation is calculated by a company’s long-run sustainable earnings multiplied by 1/cost of capital.  

 

 

What you have got then is two pictures of value: 

 

1. You have got an asset value  (AV)

2. You have got an earnings power value  (EPV)

 

 

And now you are ready to do a serious analysis of value.

 

If the picture looks like case A (AV > EPV), what is going on assuming, you have done the right valuation here? 

• What it means is say you have $4 billion in assets here that is producing an equivalent earnings power value of $2 billion.
• What is going there if that is the situation you see? It has got to be bad management. 
• Management is using those assets in a way that cannot generate a comparable level of distributable earnings.
• If it is an industry in decline, make sure you haven’t done a reproduction value when you should be doing a liquidation value. 

Notes from video lecture by Prof Bruce Greenwald

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Look at growth from the perspective of investment required to support the growth. Profitable Growth Occurs Only Within a Franchise.

Summary 
Now to summarize about growth:

1. growth at a competitive disadvantage destroys value,
2. growth on a level playing field neither creates nor destroys value, and
3. it is only growth behind the protection of barriers to entry that creates value.

Growth 
 

The standard view of short term analysts is that growth is your friend. Growth is always valuable.  That is wrong!  
 

Growth is relatively rarely valuable in the long run. And you can see why with some simple arithmetic.  I am not going to look at growth from the perspective of sales, I am going to look at it from the perspective of investment required to support the growth. 

• Now the investment required to support the growth is zero then of course it is profitable—that happens almost never (For Duff & Phelps or Moody’s perhaps). 
• At a minimum you have A/R and other elements of working capital to support growth. 

Suppose the investment required is $100 million, and I have to pay 10% annually to the investors who supplied that $100 million dollars.   The cost of the growth is 10% of $100 million or $10 million dollars.   

1.  Suppose I invest that $100 million at a competitive disadvantage. 

• Suppose I am Wal-Mart planning to compete against a well-entrenched competitor in Southern Germany, am I going to earn 10% on that investment?  Almost never.  In that case, I will be lucky to earn anything; perhaps I earn $6 million. 
• But the net contribution of the growth is the $10 million cost of the funds minus the $6 million benefit which is minus $4 million dollars for every $100 million invested. 
• Growth at a competitive disadvantage has negative value.  

 

2.  Suppose it is like the automotive industry or like most industries with no barriers to entry, it is a level playing field so the return will be driven to 10% cost by the entry of other competitors. 

• So I am going to pay $10 million, I am going to make $10 million so the growth has zero value.   

3.  Profitable Growth Occurs Only Within a Franchise 

• The only case where growth has value is where the growth occurs behind the protection of an identifiable competitive advantage. 
• Growth only has value where there are sustainable competitive advantages. 
• And in that case, usually, what barriers to entry means is there are barriers to companies stealing market share from each other.
• There is usually stable market share which is symptomatic of that last situation that means in the long run, the company will grow at the industry rate. 
• And in the long run, almost all industries grow at the rate of global GDP.   

So in these three situations, the growth only matters in the last one where its profitable (growing within a franchise) is.

• And the critical issue in valuation is either management or the G&D approach will tell you the extent to which that is important or you have a good reliable valuation and there is no value to the growth because there are no barriers to entry. 
• Or it is down here (growth is profitable) and there obviously you want to get the growth for free.
• You could pay a full earnings power value and get a decent return. (Buffett with Coke-Cola in 1988).  

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School 
Edited by John Chew at Aldridge56@aol.com                           
studying/teaching/investing Page 27

Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

You are a lot better estimating the Cost of Capital without using fancy formulas

Estimate the Cost of Capital 

You have to estimate the cost of capital.  

First of all, the cost of equity will always be above the cost of the debt.  Secondly, the most expensive cost of equity is the type that venture capitalists have to pay.  If you read the VC magazines, they will tell you what returns they have to show on their old funds to raise money on their new funds.  These days that number is 15%.  Without doing any betas, you know the cost of equity is between 7% and 15% which is a lot better than the beta estimates.  

• Usually for the low risk firm with not a lot of debt, the cost of capital will be about 7% to 8%. 
• For a medium risk firm these days with reasonable debt, it will be about 9% to 10%.  
• For high risk firms, it will be 11% to 13%.

You are a lot better doing that than trying to estimate using fancy formulas.  So you get a cost of capital.

And the nice thing about not including the growth is that errors in the cost of capital are typically not that big. If you are 1% off in the WACC, you are 10% error in the valuation and that is not a killer error in valuation. 


Notes from video lecture by Prof Bruce Greenwald

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

 

 

Cue:  7/11

Value Investing Process by Prof Bruce Greenwald

Greenwald Value Investing Class on February 12, 2008 

Retail stocks are in the tank so investors may be unreflectively selling. You will find many low market to book stocks.  You will find growing companies being dumped indiscriminately. But remember at the end of the day why are you applying this type of search strategy?   Because when you think this stock is a bargain you have to be able to explain why you are the only one who spotted that opportunity.  You have to have some rational for why the opportunity exists. 

You start with sensible search

Then value the stock: basically look at three basic elements of value: 
1. Asset Value
2. Earnings Power Value
3. Franchise Value   


Value Investing Process
SEARCH:  Obscure, distressed, Poor performance, small
VALUATION: Asset Value, Earnings Power Value
REVIEW: key issues, collateral evidence, personal biases
MANAGE RISK:  Margin of Safety, patience, You

Anybody does a DCF, I just throw it out.  Unless it is associated with a short term liquidation.

We spoke about asset values (AVs) and earnings power value (EPV). Earnings, if they are sustainable, are supported either by assets or by barriers to entry. If you had a company with a lot of earnings but no assets what sooner or later will happen to profits if there are no barrier to entry in this market?   They will be competed away.  I can do that for no assets.  No net assets, no barriers to entry and then no protection, no value.

The value of Growth is the least reliable element of value.  
You have to be able to forecast what is going to happen to growth.  It is not just looking there now and applying a value to it, you have to forecast what the changes are going to be. When you look at these things when you have done them yourself, if you look at terminal values for growing companies, you ought to have an immediate sense that it is highly sensitive to the assumptions.  And that is not comforting to a value investor who wants to have an immediate sense of what they are buying with a reasonable amount of certainty.


Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School

When you are considering buying growth stocks:

 

1.  Verify the existence of a franchise

2.  Earnings return is 1/P/E.

3.  Identify cash distribution in terms of dividends and buybacks

4.  Identify investment return of retained earnings

5.  Identify organic (low investment growth)

6.  Compare to the market (representing D/P & growth rate) - is this positive or negative?

I will give you the numbers from three years ago which we applied to a bunch of firms.  
We will look at WMT, AMEX, DELL and GANNETT. 


Company        Business                                                   Adjusted ROE
WMT              Discount Rate                                             22.5%
AMEX            High-end CC                                              45.5%
Gannett           Local NP & Broadcasting                          15.6%
Dell Direct      P/C Supply & Logistics Organization       100% 


Company          Sources of CA                          Local Economies of Scale
WMT                Slight customer captivity            Yes
AMEX              customer captivity                       Some
Gannett             customer captivity                        Local
Dell                   Slight customer captivity             Yes 


Perspective Return on the US Market 

(1) 6% return based on (1/P/E) plus 2% inflation = 8%
(2)  2.5% (Dividends/price) plus 4.7% growth = 7.2% return 

Expected Return equals 7%.   Range is 7% to 8%.  

Wal-Mart. Dell, Gannett and AMEX.

If you are thinking of investing in them, what do you want to know first? 

Is there a franchise here?

• Does WMT have CA? Yes, regional dominance and it shows up in ROE, adj. for cash of 22%. 
• Amex is dominant in their geographic and product segments. Amex dominates in high end credit cards.  
• Gannett is in local newspapers. ROC is 15.6% if you took out goodwill then ROIC would be 35% or higher.  -- 

Ross: CA can’t be just sustained, allow to grow.  CA, EOS and CC.  

Do you think different type of CA are better for allowing you to grow.  They are therefore worth looking at?  Are those franchises sustainable. 

 

With WMT there is some customer captivity in retail but there are big local and regional Economies of Scale.

• When WMT goes outside these Economies of scale they have no advantages. 
• If they go against competitors outside their regional dominance, they will be on the wrong side of the trade.  

AMEX dominates high end credit cards. 

• Do they have customer captivity? 
• (Note: Amex has been using more and more debt to generate high ROE, so the risk profile is higher). 

Comparison to the Market

• They track well because if you look at reinvestment returns, it is high because people are not investing a lot in equities. 
• Look at organic growth which is higher than it is today. 
• On the other hand, multiples have gone up. 
• There has been a secular increase in multiples of 1% to 2%.
• You have to ask yourself, is it reasonable to earn a 7% to 8% return on equities in the present climate where long bonds are earning 4%?  Historically the gap has been 8%.  

Should you use a cost of equity of 7% to 9% vs. 9% to 11%.  I think that we are talking about real assets.  That is a good question. 

• One of the things you want to do is use a lower cost of capital than 9%.
• But all of a sudden all these stocks have EPV well above their asset values. 
• Now some of that will be in intangibles.

But what should be happening?  Investment should be going up, but they are not.

• So it looks like for practical purposes with a market multiple of 16 and 2x book value, the real returns are significantly lower than that.  
• So if you have the opportunity to invest in businesses with returns greater than that, you want to value the income streams at 9% to 11% rather than 7% to 9%. 

Amex is trading back at 17 times.  Growth rate at 15%.  A classic growth stock.

• A 6% return. 
• They are committed to returning 6% to shareholders, but the 6% cash distribution will be 4%.
• They are reinvesting 2%.
• We know what they are doing with that money. They are lending it to their customers, by and large.            

 

 

Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

     

 

Calculating investment returns from growth stocks - returns from dividends and share buybacks, returns from retained earnings (reinvestment by the company) and returns from organic growth.

The calculation in the short run is not that hard to do.

1.  First you have to know where the money is going.

• Is WMT expanding in Mexico or is WMT expanding somewhere in Europe where it has no competitive advantages. 
• You can look at the simple economics with and without infrastructure costs and you see the returns if they have to build the infrastructure are about 7% to 8% which is below their cost of capital (Kcost). 
• If they can add stores to an existing infrastructure (stores near existing supply depots and other WMT stores), then the returns are more like 17% to 20%.
• But you ought to know enough about the economics of growth stocks, so you know those numbers. 

2.  You know what the reinvestment return is. 

• If the return is 20% after tax and their cost is 10%, what each dollar they reinvest worth?   $2 because they are earning 2x the cost of capital.  
• So what you are going to do is take that reinvestment return—that 5% that is reinvested and multiply it by the difference between the capital return and cost of capital.
• If they are earning 7% and Kcost is 10%, they are destroying at the rate of 3%.

3.  Is reinvesting in cash a good idea—no.

• A crappy return. 
• The longer they hold that cash the lower the return is in terms of reinvestment.   
• You are losing the return on that cash. 

So you look at the earnings return, what you get in cash, the fraction that is distributed either through buy backs and dividends and the fraction that is reinvestment and the value creation characteristics of the reinvestment.    

 

4.  Then certain companies get returns essentially without much investment--which is that if you own a franchise, even without conscious expansion, that franchise will sometimes grow.   The incremental investment involved is negligible. 

• When WMT sees an increase in SSS, it typically doesn’t have to build any new stores. 
• Especially if it is a price increase, its doesn’t have to add new people or add SKUs.
• What is the capital investment required for that increase in sales?  Only inventory.
• If their inventory turns are 8 times, then for every $1 of sales, they make about 7.5 cents in profit.
• That organic growth generates returns of about 16%. 
• They are higher than that in reinvestment because typically they will refinance two-thirds of the inventory investment with debt.
• So you will be getting returns of 150% on the capital you invest to support that organic growth. 

Why don’t returns get bid away by entrants whose store economics have improved?  That is where the existence of a franchise is crucial. If there were no barriers to entry, then gains would be get competed away by additional competitors.  So it is only growth behind those barriers that creates value.  

 

5.   You want to look next—you have your cash return, your investment return and then the return from organic growth and compare that to the return of the market to get a feel for your margin of safety is in terms of returns–then you want to see what will change that picture in a sustainable way.

 

 

Recap: 
Verify the existence of a franchise

Cash earnings return is 1/P/E.

Identify Cash distribution in terms of dividends and buybacks

Identify organic (low investment growth)

Identify investment return-multiple a percent of retained earnings

Compare to the market representing D/P & growth rate.

Identify options positive and negative.


Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Growth creates value only when the company has a competitive advantage. If there were no barriers to entry, then gains would be get competed away by additional competitors.

Why don’t returns get bid away by entrants whose store economics have improved? 

• That is where the existence of a franchise is crucial.
• If there were no barriers to entry, then gains would be get competed away by additional competitors. 
• So it is only growth behind those barriers that creates value.  

When you look at growth, this is what you look at: 
1.  First is verify the franchise.  If you don’t have a franchise, then growth is worth $0.

• Look at historical returns, share stability. 
• Look for sustainable competitive advantages. 

2.  Then calculate a return. 

• You don’t look at a P/E ratio, you look at an earnings ratio.
• If you are paying 14x earnings, it is a 7% if that P/E ratio stays the same and the earnings stay the same. You pay 11 times, it is 9%. 8 times, then 12.5%.  

3.   Out of that return there are two things that can happen to you—the first is that give it to you in your hot little hand in cash. What are you getting in cash?

• If it is a 8 times multiple, it is a 12.5% return.   
• The dividend is 2.5% and you are buying back 5% in stock per year, you are getting 7.5% in your hot little hand.
• If dividends and buyback policies are stable, then what are you getting.
• There are not stable then you have to estimate what they will be over time.  
• But you want to know what fraction of the earnings get distributed.
• So if 11 times multiple and they historically distribute a third of the earnings, 1/11 is a 9% and 1/3 of that is a 3% distribution. 

4.  What happens to the other 6%?  

• That gets reinvested—there the critical thing about the value is how effective do they reinvest that money?
• So in growth stocks, capital allocation is critical.
• Because (mgt.) is typically keeping most of your money and you care about how effectively they are investing it.      

5.  You want to look next—you have your cash return (3), your investment return (4) and then the return from organic growth.

 

6.  Compare that to the return of the market to get a feel for your margin of safety is in terms of returns–then you want to see what will change that picture in a sustainable way.  

 

 

Recap:  When you are considering buying growth stocks:

 

1.  Verify the existence of a franchise

2.  Earnings return is 1/P/E.

3.  Identify cash distribution in terms of dividends and buybacks

4.  Identify investment return of retained earnings

5.  Identify organic (low investment growth)

6.  Compare to the market (representing D/P & growth rate) - is this positive or negative?

 

 

 

Explanatory notes:

 

Dividends, buybacks & reinvestment of retained earnings:  So you look at the earnings return, what you get in cash, the fraction that is distributed either through buy backs and dividends and the fraction that is reinvestment and the value creation characteristics of the reinvestment.     

Organic growth:  Then certain companies get returns essentially without much investment--which is that if you own a franchise, even without conscious expansion, that franchise will sometimes grow.   The incremental investment involved is negligible.

 

 

 

Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Value Investing in Practice

Value Investing in Practice Long-term - Fundamental (look at underlying business) (1) Lookintelligentlyforvalueopportunities(LowP/E,M/B) o Mr. Market is not crazy about everything o This is the first step not to be confused with Value Investing (2) Knowwhatyouknow   Not all value is measurable   Not all value is measurable by YOU (Circle of Competence) (3) Youdon'thavetoswing PATIENCE

Value Investing: the Approach Search (Look Systemically for under valuation) Value Review Manage Risk

  Value implies concentration not diversification. (Look for a Margin of Safety)   At worst Buy the Market) There are three parts to being effective:

http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Greenwald Lecture at Gabelli Value Investing Conference

Published on 16 Jun 2014

Professor Bruce Greenwald lecture at Gabelli Value Investing Conference at Princess Gate, London in 2005. He looks at the art of value investing and investment processes.

Understanding Value Investing (video)

Professor George Athanassakos, Professor of Finance and the Ben Graham Chair in Value Investing at Ivey Business School, which he joined in July 2004. He is also the Founder & Director of The Ben Graham Centre for Value Investing.

Speculation

http://www.slideshare.net/thadeshvar/basics-of-wealth-mgt

5 Reasons Why You Should Invest In Malaysian REITs Now

 contributor Finance Oct. 3, 2014

Malaysian property investments have become less attractive these days due to the skyrocketing prices and also the various cooling measures implemented by the authorities. This has set many people from the middle and lower income groups back from buying their first home or investing in property.
However, other than investing in physical properties, Malaysians can consider investing in Malaysian Real Estate Investment Trusts (MREITs). Unlike business trusts, Malaysian REITs are trusts which invest in properties only. They are traded on stock exchanges and are eligible for special tax exemption.

Here are five reasons why you should invest in REITs in Malaysia:

1. Small starting capital

Most property investments require a significant amount of money to start. Even with 90% loan, a RM500,000 property would require at least RM50,000 down payment plus extra for legal fees and stamp duties. For MREITs, you can start investing with as little as RM140 (100 shares of Pavilion REIT at RM1.40).

2. Get exposure to the top shopping malls and commercial buildings

With MREITs, you will be able to buy into the top shopping malls in Malaysia. Malls such as Pavilion (Pavilion REIT), MidValley Megamall (IGB REIT), Sunway Pyramid (Sunway REIT) are all available on Bursa Malaysia. As an individual property investor, you would have little chance of owning such popular shopping malls, other than certain strata title types like Berjaya Times Square. With MREITs, your dream of owning a part of these popular commercial properties can be a reality.

3. Earn regular dividends

Like property rentals, MREITs also generate income in the form of dividends. Since MREITs are usually diversified, vacancy rates are generally low so they are a more stable form of income as compared to physical properties which could have vacancy periods.
The frequency of dividends payout for REITs is quarterly or bi-annually, making them an ideal investment for retirement income. To make it even more attractive, the dividend payout for REITs tend to be pretty high as they need to pay out at least 90% of their net income to be eligible for tax treatment.

4. Ease of buying and selling MREITs

As MREITs are exchange traded, buying and selling them is generally easier compared to physical properties. MREITs are bought and sold like normal stocks so the prices are transparent and the transactions take place instantly. For property transactions, it is normal to take between six to 12 months at least to find the right buyer at the right price and go through the sales and purchase agreement (SPA) process.

5. Minimal effort required

One of the key advantages of MREITs is that there is minimal effort required to maintain these investments. MREITs hire professional management teams to manage the tenants and upkeep of the properties, leaving you to enjoy the fruits of your labour. Anyone familiar with property investments will know that there is in fact a lot of work involved in managing your own properties.
At current market condition, dividend yields of most MREITs are pretty attractive compared to other investments, ranging from 5% to 6%. Given the stability of the dividend income and quality of the properties, MREITs are generally good investments to consider.
About the Author
Calvin Yeo, CFA, CFP is the Managing Director of DrWealth. Dr Wealth is ASEAN’s leading site on personal finance. We offer users high quality articles and research on all areas of Personal Finance including Retirement Planning, Investments, Savings, Insurance etc. In addition, we provide effective and simple to use mobile and desktop software tools that help you track, model and plan all your finances.


http://www.businessinsider.my/5-reasons-why-you-should-invest-in-malaysian-reits-now/#.VC6xE0lXjIU

GDP accurate measure of economic growth

October 3, 2014       

KUALA LUMPUR: There is no denying that consistent economic growth reflected in the country’s Gross Domestic Product (GDP) has increased wages and raised the quality of Malaysians from all walks of life.
Consumers now have more products and services to choose from and higher disposable income, thanks largely to well-managed economic policies that keep creating thousands of jobs for the people.
Without doubt, GDP is an accurate barometer of how well-off we are.
But, detractors who suggest otherwise simply haven’t made the effort to understand the basics of economics.
It’s high time the people started looking at the facts and having their own opinions based on intelligent logic, rather than jumping on the bandwagon of the loudest critics.
GDP figures reflect how our economy performed in the past quarter or year.
Unfortunately, while the majority are able to grasp that positive GDP growth is good for all Malaysians, there is a vocal minority who fail to see this or simply refuse to do so.
Between 2011 and 2013, the Malaysian economy recorded a GDP growth of 5.2 per cent per annum.
For the first half of 2014, GDP was 6.3 per cent, driven primarily by growth of the services, manufacturing, construction and agriculture sectors.

So what do these numbers actually mean?
To figure this out, it’s crucial to understand what GDP is all about.
Malaysia, like most other countries in the world, measures GDP using three methods — expenditure, type of economic activity and income.
With the expenditure method, it is calculated by adding total consumption, investment, government spending and net exports.
Net exports are a measure of the output of goods and services assembled and produced in Malaysia and sold abroad minus the imports.
Consumption is what people spend their money on – goods such as your food, the petrol for your car and the clothes you wear, and services such as hair dressing, visits to the doctor, making calls, sending WhatsApp using smartphones and going to the cinema.
An economy with a healthy level of consumption is one where businesses are thriving.
Thriving businesses creates jobs and there are generally low levels of unemployment.
It also means that money is circulating in the economy which provides for greater revenue as well as higher personal and corporate income.
Investment is linked to job creation – as our productive capacity increases with more investment and job opportunities abound, made more glaring by foreigners seeking their fortunes in Malaysia.
Moreover, money is also coming from foreign direct investments from renowned investors such as Intel, Samsung, Honda and others.
Most of the investments are in the oil and gas sector, financial services as well as the wholesale and retail sectors.
Some of Malaysia’s investment strategies are found within the parameters of the Economic Transformation Programme which aims to make Malaysia a high income economy by the year 2020.
Government spending is evident in more and better infrastructure – from public transport, to healthcare including hospitals, 1Malaysia clinics and education services and schools.
Besides this, it comprises stimulus packages to encourage businesses, and general improvements for civil society in the form of sports, cultural and artistic facilities.
It also includes innovation in government delivery services such as the Urban Transformation Centre – which can be found in Pudu and Sentul in Kuala Lumpur, Kuantan, Melaka, Ipoh and Alor Setar – and the Rural Transformation Centre such as the ones in Gopeng and Kota Bharu.
For the detractors, their main gripe is that they still don’t have enough money for all that their hearts desire. Figures, however, show that Malaysian wages have increased, with the wages to GDP ratio improving from 29.3 per cent in 2008 to 33.6 per cent in 2013.
Wages refer to what employees earn in the course of their job, in cash or in kind, such as salaries and wages, gratuity, bonus, subsidies and benefits.
GDP, in relation to wages, is used as a measure of productivity. Therefore, an increasing ratio of wages to GDP shows that people are now paid more for their productivity than they were in 2008.
In 2012, based on the Household Income Survey by the Department of Statistics, the average household income was RM5,000 per month while the median income was RM3,626 per month.
Two years on, based on the preliminary data, the average household income has risen to RM5,919 while the median income is RM4,258, representing an annual median income growth of 8.2 per cent. A household here is referred to 4.2 individuals.
There are those who claim that the rise in cost of living outstrips wage increases. This is a grossly uninformed opinion.
For the first seven months of 2014, the Consumer Price Index, which monitors the price of perishable and non-perishable goods, averaged 3.3 per cent per annum. This means that the rate of growth in household income exceeded the increase in the price of goods.
Ultimately, this has resulted in Malaysians benefitting from an improvement in living standards, as evident from changing consumer choices and consumption behaviour patterns.
The Malaysian consumer now not only has a higher purchasing power, but also a greater power of choice.
A quick look at the price comparison website http://www.1pengguna.com/ verifies this.
Looking at the price of red grapes with seeds in the Lembah Pantai area, the price on Sept 22, 2014 for a kilogramme of these grapes was RM17.90 in the Village Grocer in Bangsar Village, RM12 at the Jalan Telawi Wet Market, RM9.99 at TMC and RM8.49 in Aeon Big in Bangsar South.
So even when it comes to buying grapes, Malaysians now have a plethora of choices of where they can buy it from and how much it will cost. We certainly didn’t have this same variety of choice a decade ago.
Undoubtedly, economic expansion via the GDP is an accurate measure of the nation’s economic growth underpinned by pro-growth policies that takes into account the welfare of the people.
For sceptics to say otherwise is irresponsible and smacks of attempts to nullify the economic success achieved thus far by Malaysia despite the immense challenges it faces brought on by challenges in regional and global economies. – BERNAMA

PIMCO’s Flagship Fund Sees Its 17th Straight Monthly Outflow, And It Was Massive

PIMCO’s flagship Total Return Fund saw a breath taking $23.5 billion in net outflows in September.
“Of note, the largest daily outflow occurred on the day of Bill Gross’s resignation from the firm, while outflows on the two following days were considerably smaller,” PIMCO said in a press release.
That was the 17th straight month of net outflows for a cumulative total amount of about $92 billion.
All of this is part of the legacy that CIO Bill Gross leaves behind as he heads to Janus Capital.
PIMCO has attracted a lot of attention in recent months, largely because of the unexpected departure of CEO Mohamed El-Erian and revelations of Gross’s unorthodox management style.
Despite the outflows, PIMCO’s fund continues to be massive with roughly $200 billion in assets under management.


Sam Ro Finance Oct. 2, 2014, 4:30 AM
http://www.businessinsider.my/pimco-total-return-fund-outflows-sept-2014-10/#.VC6t90lXjIU

The Bill Gross Blunder That Led To His Demise

 

Joe Weisenthal Finance Oct. 2, 2014, 11:39 PM

 

Bill Gross

In the wake of Bill Gross’ shock departure, Paul Krugman has been hammering on an important point, which is that PIMCO really started hitting the rocks when Bill Gross made a wrong call about interest rates in 2011.
Paul Krugman has written four posts on the topic (here, here, here, and here).
So what’s it all about?
Well here’s the quick and dirty version.
In early 2011, Bill Gross completely exited the Treasury market on the premise that interest rates were going to surge and hit bonds.
The reason he thought interest rates were going to surge was that the Fed was ending QE2 in the summer of 2011. In a note written to investors in March, 2011 he asked:  Who will buy Treasuries when the Fed doesn’t?
The thinking was that the Federal government was running gigantic, trillion-dollar deficits at the time, and that nobody wanted all that US debt, and it was only the Fed buying debt, holding our interest rates down.
That sounded compelling, but actually was pretty flimsy, and even at the time people were criticizing the thinking.
Krugman was criticizing Gross at the time, arguing that interest rates weren’t a function of how much debt the US was offering, but rather about US growth and inflation prospects. And since at the time, we were digging ourselves out of a gigantic economic hole, there was no chance of a pickup in inflation.
So Gross was using a flawed economic model (as were the deficit hawks who insisted that the US had to get its spending down to avoid a Greece-like bond spiral).
When QE2 ended, interest rates didn’t rise… they actually fell, perhaps because the markets interpreted the end of Fed easing as a reason to bet against rising inflation or growth.
This was THE core economic debate of the post-crisis years. The economists like Krugman, who relied on traditional models, correctly surmised that interest rates would not surge and that the debt would be a problem.
Folks like Bill Gross (and Republicans politicians) thought the Fed was distorting the market, and keeping interest rates from surging, and that turned out to be wrong.
And that lead to a period of underperformance for PIMCO, and the start of the turmoil that saw significant outflows, and ultimately the departure of Mohamed El-Erian and then Gross.
These debates mostly aren’t talked about now, but as stated above, this was really the whole story back in the day. And it ended up costing Gross his role in the company he created.

http://www.businessinsider.my/this-was-the-bill-gross-blunder-that-led-to-his-downfall-2014-10/#.VC6t0klXjIU

Legendary Warren Buffett shares his simple investing secrets.

CNBC Excerpts: Legendary Investor Warren Buffett Speaks with CNBC's "Squawk Box" Today

 

October 2nd
WHERE: CNBC's "Squawk Box"

Following are excerpts from the unofficial transcript of a CNBC interview with Billionaire investor Warren Buffett today on CNBC's "Squawk Box." Video from the interview is available on CNBC.com.


BUFFETT ON BERKSHIRE HATHAWAY BUY
I DO HAVE SOME GOOD NEWS AND IT INVOLVES LARRY. YESTERDAY WE SIGNED AN AGREEMENT, BERKSHIRE HATHAWAY SIGNED AN AGREEMENT TO BUY VAN TUYL AUTO WHICH IS OWNED AND RUN BY LARRY AND WE HAVE KNOWN EACH OTHER FOR SOME TIME. LARRY HAS 78 DEALERSHIPS, VOLUME OF ABOUT 9 BILLION.

BUFFETT ON VAN TUYL DEAL
SIX MONTHS OR THEREABOUTS, LARRY CAME BY AGAIN. HE'D BEEN TO OUR ANNUAL MEETINGS AND HE KNEW HE WANTED TO DO BUSINESS WITH BERKSHIRE. AND THIS IS JUST A VERY, VERY GOOD OPERATION. THIS PARTNERSHIP APPROACH THAT HE HAS WORKED EXTRAORDINARILY WELL. HE'S JUST KEPT ADDING DEALERSHIPS OVER THE YEARS. THERE'S AN INSURANCE COMPANY INVOLVED, THERE'S REAL ESTATE INVOLVED. AND HE WANTED TO BE SURE THAT VAN TUYL ENDED UP IN A PERMANENT HOME. SO WE WORKED OUT A DEAL VERY QUICKLY.

BUFFETT ON BILL GROSS
CERTAINLY WHAT I KNOW ABOUT HIS RECORD HAS BEEN TERRIFIC AND IT IS NOT EASY TO RUN, YOU KNOW, HUNDREDS OF BILLIONS OR MAYBE TRILLIONS OF DOLLARS. THAT IS A REAL TASK. SO TO HAVE A GOOD RECORD – AND IT MAY HAVE GOTTEN MORE DIFFICULT AS THE NUMBERS GOT LARGER, I DON'T KNOW. CERTAINLY THAT IS TRUE IN EQUITIES. THERE IS NO QUESTION ABOUT THAT, BEING THE SITUATION IN EQUITIES. BUT HIS RECORD HAD TO BE – HE DIDN'T ATTRACT THAT MONEY JUST ON HIS PERSONALITY.

BUFFETT ON BOND MARKET
STEVE LIESMAN: WHAT DO YOU SEE WHEN YOU LOOK AT THE BOND MARKET TODAY? THE U.S. TREASURY AT 240?
WARREN BUFFETT: WELL I DON'T START SALIVATING, I'LL PUT IT THAT WAY. NO, I MEAN, YOU KNOW YOU ARE GOING TO DO BETTER THAN 240 IF YOU OWN EQUITIES OVER A LONG PERIOD OF TIME. YOU KNOW, AND THEN SO, IF YOU TALK ABOUT 240 FOR TEN YEARS, YOU KNOW, I WOULD JUST LOVE TO TAKE A BET ON EQUITIES.

BUFFETT ON DEMAND FOR CARS
CARS AREN'T GOING LIKE THAT. DEALERSHIPS MAYBE. THAT MEANS EVERY DEALERSHIP IS GOING TO SELL MORE CARS, ON AVERAGE. SO THE PATTERN HAS CHANGED, BUT THE FUNDAMENTAL DEMAND FOR CARS IS NOT GOING DOWN. THE AVERAGE DEALERSHIP WILL DO A LOT MORE BUSINESS NOW THAN IT DID 30 OR 40 YEARS AGO IN TERMS OF UNITS.

BUFFETT ON STOCKS
WE ACTUALLY BOUGHT A FEW STOCKS YESTERDAY, BUT WE BOUGHT THE BUSINESS YESTERDAY, TOO. AND IF YOU TOLD ME THE MARKET WAS GOING TO GO DOWN 500 POINTS NEXT WEEK, I WOULD HAVE BOUGHT THOSE SAME BUSINESSES AND STOCKS YESTERDAY. #####I DON' KNOW HOW TO TELL WHAT THE MARKET IS GOING TO DO, I DO KNOW HOW TO PICK OUT REASONABLE BUSINESSES TO OWN OVER A LONG PERIOD OF TIME. AND A LOT OF PEOPLE DO. #####

BUFFETT ON TESCO
BECKY QUICK: ALTHOUGH, THERE ARE TIMES WHEN THE BUSINESS IS NOT WHAT YOU THINK IT IS, LIKE A TESCO.
BUFFETT: WELL, IF YOU MAKE A MISTAKE –
QUICK: TALKING ABOUT GROCERIES REMINDS ME OF TESCO, THOUGH.
BUFFETT: WELL, YEAH, TESCO WE DEFINITELY MADE A MISTAKE – I MADE A MISTAKE ON THAT ONE. IT WASN'T ANYONE ELSE WHO MADE IT. YEAH, THAT WAS A HUGE MISTAKE BY ME. BUT, I'M GOING TO MAKE MISTAKES. #####BUT I'M NOT GOING TO MAKE MISTAKES BECAUSE I BUY BUSINESSES I LIKE AS THEY GO DOWN IN PRICE.##### I'M JUST GOING TO BE WRONG SOMETIMES ON THE FACTS. BUT THE IDEA OF BUYING A STOCK BECAUSE IT HAS GONE UP, TO ME IS JUST TOTALLY –

BUFFETT ON COCA-COLA PAY
THE NEW PLAN MAKES GREAT, GREAT SENSE. THEY'RE NOT REDUCING THE AMOUNT THEY PAY. I MEAN, A LOT OF PEOPLE WILL GET CASH INSTEAD OF STOCK. THEY RE-EXAMINED THE COST OF THE COMPANY IN TERMS OF GIVING UP SHARES. AND WHICH PEOPLE WOULD BE MOTIVATED BY SHARES AND WHICH ONES WOULDN'T. AND THEY CHANGED THE MIX TO PERFORMANCE SHARES.

BUFFETT ON AMERICAN BUSINESSES
ANYBODY WHO OWNED A CROSS SECTION OF AMERICAN BUSINESS OVER THE LAST 10 YEARS, 20 YEARS, 30 YEARS, 40 YEARS, 50 YEARS, 60 YEARS, HAS DONE FINE. NOW, IF THEY THINK THEY CAN DANCE IN AND OUT, YOU KNOW, AND BUY AND SELL STOCKS, I MEAN, THEY OUGHT TO HEAD FOR LAS VEGAS. I MEAN, THEY CAN'T DO THAT. BUT WHAT THEY CAN DO, IS DETERMINE THAT THERE ARE A NUMBER OF SOLID AMERICAN BUSINESSES, A GREAT NUMBER OF THEM, AND IF YOU OWN A CROSS SECTION OF THEM, AND PARTICULARLY IF YOU BUY THEM OVER TIME, YOU BASICALLY CAN'T LOSE.

BUFFETT ON BURGER KING AND TAX INVERSION
THERE WAS ALL THIS MATERIAL WRITTEN ABOUT HOW TAX MOTIVATED THIS PURCHASE MIGHT BE. ALL KINDS OF COMMENT. I DID NOT READ ONE ARTICLE ANY PLACE. NEVER. WHERE ANYBODY LOOKED UP AND SAW WHAT BURGER KING WAS PAYING IN TAXES. HOW MUCH WAS BURGER KING PAYING IN FEDERAL INCOME TAXES IN THE LAST THREE YEARS? THE HIGHEST FIGURE. NOBODY KNOWS. BECAUSE ALL THEY KNOW IS IT MUST BE A TAX DEAL. THE HIGHEST NUMBER IN THE LAST THREE YEARS THAT BURGER KING PAID IN TAXES WAS $30 MILLION. NOW, THIS IS AN $11 BILLION DEAL. ANYBODY CAN IMAGINE PAYING $11 BILLION FOR A BUSINESS BECAUSE SOMETHING IS PAYING $30 MILLION IN FEDERAL INCOME TAXES. IT WAS NOT A TAX MOTIVATED DEAL.

BUFFETT ON BURGER KING
IT DOESN'T HAVE ANYTHING TO DO WITH TAXES. I MEAN, IT HAS TO DO WITH THE FACT THAT TIM HORTON EARNS TWICE AS MUCH MONEY AS BURGER KING DOES. AND THE DEAL HAS TO BE APPROVED BY THE CANADIAN GOVERNMENT. IT HAS TO GO BEFORE INVESTMENT GROUP AND THEY HAVE TO SEE A BENEFIT. NOW, WHAT IS THE BENEFIT TO CANADA IF SOME COMPANY THAT EARNS TWICE AS MUCH AS THEY ACQUIRE IS GOING TO BE BOUGHT BY AN AMERICAN COMPANY? I'M NOT SURE HOW YOU GET THAT ONE BY.

BUFFETT ON CHANGING THE TAX CODE
I AGREE THAT THE TAX CODE SHOULD REALLY BE CHANGED. THE INTERESTING THING IS YOU'VE GOT RON WYDEN AND YOU'VE GOT ORRIN HATCH. THEY ARE INTELLIGENT, THEY'RE PATRIOTIC, THEY'RE PERFECTLY DECENT INDIVIDUALS. THEY COULD WRITE A BETTER CORPORATE TAX CODE THAN EXISTS NOW. NEITHER ONE WOULD LIKE IT PERFECTLY WHEN THEY GOT THROUGH. BUT IF THEY WRITE ONE AND IT'S REVENUE NEUTRAL THAT MEANS A LOT OF PEOPLE ARE GOING TO HAVE THEIR TAXES INCREASED AMONG CORPORATIONS. AND THEY WILL BE THE ONES WHO WILL BE LOBBYING LIKE CRAZY.

BUFFETT ON GETTING CORPORATE TAX REFORM
I WILL GUARANTEE YOU THAT RON WYDEN AND ORRIN HATCH DISAGREE SIGNIFICANTLY ON A LOT OF POINTS, BUT I THINK THEY COULD WRITE SOMETHING THAT THEY WOULD BOTH AGREE IS BETTER THAN WHAT WE HAVE AND NOT WHAT THEY WOULD LIKE. AND I WOULD LOVE TO SEE THEM DO THAT. AND THEN I WOULD LOVE TO SEE CONGRESS TAKE IT UP. BUT IF YOU'RE TALKING ABOUT ANYTHING THAT'S REVENUE NEUTRAL. YOU ARE GOING TO HAVE A LOT OF PEOPLE WHO ARE GOING TO PAY MORE. AND YOU KNOW, THEY WILL MAKE OCCUPY WALL STREET, IT'LL BE OCCUPY K STREET, IS WHAT WILL HAPPEN. I ACTUALLY THINK THERE'S SOME CHANCE OF IT GETTING DONE IN CORPORATE REFORM. BECAUSE IT SHOULD BE.

BUFFETT ON U.S. ECONOMY
IT'S REALLY AMAZING TO ME. SINCE THE THIRD QUARTER OF 2009, LOOKING AT OUR BUSINESSES, THEY'VE IMPROVED AT A RATHER CONSTANT PACE. NOW, WE HEARD TALK ABOUT DOUBLE DIPS. WE HEARD TALK ABOUT EVERYTHING. THEY'VE NEVER DECELERATED MUCH, THEY'VE NEVER ACCELERATED MUCH. NOW, AUTOS ARE DOING WAY BETTER THAN AVERAGE. HOUSING IS DOING WORSE THAN I WOULD HAVE ANTICIPATED. BUT IF YOU LOOK AT THE OVERALL, IT'S BEEN REMARKABLY CONSISTENT. AND THE MOOD SWINGS HAVE BEEN SUBSTANTIAL, BUT IT HAS BEEN FIVE YEARS. BUT THIS WAS A RECESSION LIKE NONE WE'D EVER HAD. I MEAN, THIS IS A RECESSION WHERE EVERYBODY THROUGHOUT THE COUNTRY JUST GOT PLAIN SCARED. NOW, WE'VE HAD A LOT OF RECESSIONS WHEN SOME PEOPLE GOT WORRIED OR SOMETHING LIKE THAT AND WE KNEW WE WERE IN ONE. BUT YOU HAD – OUR BASELINE HERE WAS PEOPLE WANTING TO PUT MONEY UNDER THE MATTRESS. AND THAT IS A DIFFERENT SORT OF RECESSION THAN, YOU KNOW, WE'VE HAD IN MY LIFETIME. BUT WE'RE COMING BACK.

BUFFETT ON INVESTING
YOU WANT TO INVEST IN THINGS YOU KNOW. I KNOW BUSINESSES. I DON'T KNOW ALL BUSINESSES. I MEAN, THERE ARE THOUSANDS OF THEM I DON'T UNDERSTAND WELL, BUT I KNOW ENOUGH. AND YOU WANT TO INVEST IN THINGS YOU KNOW. IF YOU DON'T INVEST IN THINGS YOU KNOW, YOU'RE JUST GAMBLING, BASICALLY. AND SO YOU LOOK FOR WHAT YOUR CIRCLE OF COMPETENCE IS. YOUR COMPETENCE MAY BE REAL ESTATE, IT MAY BE FARMING, IT MAY BE BUSINESSES. MINE OVERWHELMINGLY IS BUSINESSES, ALTHOUGH EVERY NOW AND THEN I DO A LITTLE SOMETHING ELSE. SO I DON'T THINK YOU CAN ANSWER SOMETHING LIKE THAT CATEGORICAL. THE ONE THING YOU SHOULDN'T DO IS YOU SHOULDN'T BUY ANYTHING WHERE YOU DON'T THINK YOU HAVE A REASONABLY GOOD IDEA WHERE IT WILL BE IN FIVE OR TEN YEARS.

BUFFETT ON HEDGE FUNDS
I MADE A BET SEVEN YEARS AGO AND I MADE THIS OFFER TO ANYBODY IN THE UNITED STATES. I SAID I BET A MILLION DOLLARS THAT THEY COULD PICK ANY GROUP OF FUND-TO-FUNDS OF HEDGE FUNDS AND I WOULD TAKE THE S&P 500 RUN BY VANGUARD AND THE WINNER WOULD GET TO PICK THE CHARITY THAT THE MONEY WENT TO. AND ALL I CAN TELL YOU IS I'M QUITE AWAYS AHEAD ON THAT BET NOW. HEDGE FUNDS AFTER FEES ARE NOT GOING TO DELIVER, IN MY VIEW, A RETURN AS WELL AS BUYING A LOW-COST INDEX FUND. BUT THEY ARE GOING TO MAKE A LOT OF MONEY FOR THE PEOPLE WHO RUN THEM.

BUFFETT ON VIRGINIA ROMETTY
I THINK SHE IS DOING EXACTLY THE RIGHT THING. YOU KNOW, WE NOW OWN SLIGHTLY OVER 7% OF IBM. AT THE TIME WE BOUGHT IT, I THINK THEY HAD 1.6 BILLION SHARES OUT. NOW THEY HAVE UNDER A BILLION. SHE IS MAKING THE RIGHT MOVES. IT'S A BIG COMPANY. SO MAKING CHANGES IS NOT EASY.

http://www.cnbc.com/id/102054108#.