Apr 112016
 

The recently released 103 page transcript of the Financial Crisis Inquiry Commission Interview of Warren Buffett on May 26, 2010 provided some very interesting insights into the causes of the financial crisis, its consequences on the shareholders of financial institutions, and on stock market valuation.

(1) Stock Market Valuation – Mr Buffett cites a 1924 book by Edgar Lawrence Smith that concluded that stocks always outperform bonds “when the dividend yield on stocks was the same as the yield on bonds, and on top of it you had retained earnings.”  If we were to apply this rule of thumb to today’s stock market, the current dividend yield on the S&P 500 of 2.12% exceeds the yield on  10-year U.S. Treasury bond (1.72%), as of the market close on April 8, 2016.  Furthermore, a better measure, the earnings yield of the S&P 500 (inverse of the P/E ratio) equals 4.43%.  By these measures, stocks should be expected to outperform bonds, at least in the short or intermediate term.

(2) Bubbles  – The housing bubble resulted from the almost universal expectation that the prices of houses can only go up.

(3) Smoothing Earnings – Warren Buffett sold his major stake in Freddie Mac (FRE) when management promised steady earnings growth.  This implied potential manipulation of accounting in order to achieve this goal in a cyclical economy.  FRE was also starting to invest in the bond of a major tobacco company which had nothing to do with its mission of promoting home ownership.

(4) Moral Hazard – When the Federal Government stepped in to assist many financial institutions through TARP, etc.,  the shareholders of these companies lost between 90  and 100% of their investment.  Bear Stearns stock went from 180 down to 10.  This assistance was required to restore confidence in the financial system.  Those who criticized the government’s actions on grounds of “moral hazard” were wrong, as the equity of these firms was essentially wiped out.  Unfortunately,  wealthy CEO’s were able to walk away while being able to maintain the bulk of their wealth. Mr. Buffett recommends that any company that requires financial aid from the U.S Government should have the wealth of the CEO and his/her spouse wiped out.

(5) Derivatives – Derivatives injected enormous leverage and counterparty risk.  The more complex and opaque the derivative, the more profitable it was sell.  Lehman had a large derivative book with numerous counterparties.

(6) Leverage – If you do not have leverage, you do not get into trouble.  Leverage is the only way a smart person can go broke.  If you are smart, you do not need it, and if you are dumb, you should not be using it.

(7) Econometric Models – Models work 98% of the time.  They never work 100% of the time.

(8) Opaque – If an investment is opaque, walk away.

(9) Ken Lewis – If Ken Lewis (Bank of America) had not bought Merrill Lynch, the financial system would have collapsed.

(10) United States vs. Europe – In the U.S. during the financial crisis we saved ourselves.  By contrast, European countries faced the dilemma of saving other countries.

 

 

 

 

 Posted by at 12:21 am
Mar 242016
 

I am quoted in an Omaha World-Herald article on the increasing frequency and severity of automobile insurance claims and the resulting rise in premiums at Berkshire Hathaway’s Geico:

All told, both the severity and frequency of claims have been on the rise at Geico, said David Kass, a business professor at the University of Maryland and a Berkshire Hathaway shareholder.

“This resulted from lower prices for gasoline and an improving economy, which led to more miles being driven by policyholders,” Kass said. “These increases in costs to auto insurers reduces their profitability in the short run until appropriate premium increases can be implemented.”

Also:

“This float is a major source of funds for Berkshire to invest both inside the company as well as outside the company through acquisitions and investments in publicly traded companies,” Kass said. “The insurance businesses in Berkshire are the engine that drives the company. The float provides the fuel.”

But without an underwriting profit, insurance float gets eaten up, with paid-in premiums going out as fast as they come in, depriving the company of their use in the meantime. So preserving underwriting profit via rate increases is axiomatic, Kass said. Ratepayers are going to absorb it; blame the hospitals and lawyers, perhaps, but it will be absorbed one way or another.

“The premium increases are being introduced with a lag of six months, the length of an auto policy,” Kass said. “But they will be set at sufficient levels to cover the higher costs.”

 Posted by at 7:56 am
Mar 012016
 

Warren Buffett was interviewed on CNBC on February 29, 2016 from 6:00 a.m. – 9:00 a.m. eastern time.  These are some of the highlights:

(1) Warren Buffett does not predict stock prices in the short run, but in the long run they will be higher (10, 20, 30 years from now).  He has been buying stocks in 2016 (Phillips 66) and is a more aggressive buyer when they go down.  Real GDP in the U.S. has grown at 2% per year since the financial crisis of 2009.  He bought his first stock in April 1942 at age 11 when the U.S. was losing World War II in the Pacific.  He bought shares after 9/11 and after the crash of 1987 (Coca-Cola in March 1988).

(2) Lower oil prices result in a gasoline dividend for consumers and are good for oil importing countries such as the U.S.  This gasoline dividend feeds slowly into the economy as consumers save initially and then gradually spend more.  But, the capital value of the oil industry drops quickly with an accompanying loss of jobs.  The railroad industry had a bad year in 2015 as well as in the first quarter of 2016.  34% of rail car loads are affected by lower oil prices, coal, and fracking sand.

(3) The frequency of auto accidents and number of related deaths rose in 2015 as more miles were driven resulting  from lower gas prices and greater employment.  1/2 of deaths result from people not wearing seat belts, 1/3 from drunk driving, and 10% from distracted (smart phones) driving (about 3,000 of 36,000 deaths in 2014).  Insurance rates are increasing to match the increase in frequency and severity of claims.  But thanks to Ralph Nader and new technology, cars are a lot safer than they used to be.  Driver-less cars will succeed if they are safer.

(4) Warren Buffett does not think he is wrong by investing in IBM, but he says it could be a mistake.  He was wrong about Tesco (British retailer).  If he is wrong, he will sell and may take a big loss. Lower prices for a stock is good if he is buying more, unless the company is losing value (if it is not worth what it is selling for).  He has never sold a share of IBM.  A  good business is more important than its management.   Geico is working closely with IBM’s Watson computer (artificial intelligence),

(5) Berkshire is webcasting its annual meeting this year since they were “maxed” out in 2015 with 45,000 people.

(6) Berkshire is closing on its purchase of Duracell today (in exchange for its Procter & Gamble stock).

(7) He does not know how negative interest rates will play out.  This has not been studied before. Negative interest rates help borrowers and hurt savers.

(8) He cannot name one economist with a 160 IQ who became super wealthy from stocks.  Keynes became a value investor (buy and hold) later in life.

(9) Productivity growth is a goal of society.  3G Capital turns inefficient companies into efficient ones.  We need the best people running our companies for the 150 million Americans who work there.

(10) Warren Buffett is unlikely to own Dow Chemical common stock at conversion of its convertible preferred.  He likes the preferred stock only.

(11) Coca-Cola’s growth rate has slowed down.

(12) American Express has a terrific reputation and will do fine over time.

(13) At Wells Fargo, CEO John Stumpf has done a fabulous job.

(14) Berkshire is likely to convert its warrants into the common stock of Bank of America (by 2021).

(15) Kinder Morgan is an investment of either Todd Combs or Ted Weschler.

(16) Phillips 66 is an investment of Warren Buffett.  The current economics of oil refining is better than oil producing.

(17) Clayton Homes has not been engaging in predatory lending by charging minorities higher interest rates.  Its average interest rate is 8.8%.

(18) He hopes the United Kingdom stays in the European Union.

(19) With respect to global warming, insurance rates will rise gradually over time.  Florida is now going through the longest period without a hurricane hitting land since the late 1800’s.

(20) Students should follow their passion.  He (investing) and Bill Gates (coding) achieved early success (age 13- 18) through “focus”.

 Posted by at 12:34 am
Feb 282016
 

On Saturday, February 27, Warren Buffett released his Letter to Shareholders.  Some of the highlights are:

(1) He praised 3G Capital for buying, building, and holding large businesses in contrast to private equity firms that sell the businesses they acquire.

(2) Berkshire’s “appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash.  Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us”.

(3) “For 240 years it’s been a terrible mistake to bet against America…America’s kids will live far better than their parents did.”

(4) “Our definition of interest coverage is the ratio of earnings before interest and taxes to interest, not EBITDA/interest, a commonly used measure we view as seriously flawed.”

(5) With respect to GAAP treatment of stock-based compensation: “If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?”

(6) He provided a vigorous defense against charges of predatory lending at Clayton Homes.  Clayton Homes retains 100% of of its mortgages so its economic interest is aligned with those of its customers.  Clayton Homes is subject to oversight by several Federal agencies and its total fines over the past two years were only $38,200, with refunds to customers of $704,678.  “Furthermore, though we had to foreclose on 2.64% of our manufactured-homes mortgages last year, 95.4% of our borrowers were current on their payments at year-end, as they moved toward owning a debt-free home.”

(7) He provided a discussion of the importance of productivity growth on prosperity, citing examples from farming, railroads, and automobile insurance, and the important role played by 3G Capital.

 

I am quoted in two Omaha World-Herald articles on Buffett’s Letter to Shareholders:

David Kass, a business professor at the University of Maryland and a Berkshire Class B shareholder, said 3G and Berkshire have clearly different business models but share one trait: They buy and plan to hold long term, as opposed to private equity firms, which enact wholesale changes to wring out profits and then sell quickly at top dollar.

“Berkshire does things differently than 3G,” Kass said. “But Buffett is saying that he is proud to be their financing partner.”

http://www.omaha.com/money/buffett/buffett-prepare-yourself-for-the-painful-cost-cutting-across-corporate/article_d3e9512a-ac30-5a96-842f-332b961bde8e.html

“It was an extremely vigorous defense of Clayton Homes,” said David Kass, a business professor at the University of Maryland and owner of Class B shares.

Kass said Buffett took pains to point out that Clayton owns in perpetuity all of the mortgages it writes as opposed to selling them, as other lenders do, ostensibly meaning the company would do its best to keep borrowers from defaulting and getting repossessed.

http://www.omaha.com/money/buffett/buffett-touts-advantages-of-berkshire-s-growth-formula-buy-part/article_bc98daa7-0c18-5da3-9b74-5c3006de20ab.html

 Posted by at 3:46 pm
Feb 212016
 

I am quoted in an Omaha World-Herald article (February 21, 2016) on Berkshire Hathaway’s (NYSE: BRK.A) (NYSE: BRK.B) investment in Kinder Morgan (NYSE:KMI).

“Kinder Morgan fits Warren Buffett’s toll bridge model,” said David Kass, a business professor at the University of Maryland and owner of Class B Berkshire shares. “The concept of owning a toll is appealing because generally there is no alternative, which forces people to pay the toll. Or, if there is an alternative, it is less appealing.”

 Posted by at 10:03 am
Feb 172016
 

After the market closed on February 16, 2016, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) reported its equity holdings of U.S. based companies in its SEC 13F filing for the quarter ending December 31, 2015.  This report revealed one major initial investment of about $400 million in oil and gas pipeline company Kinder Morgan (NYSE:KMI).  It is believed that this investment was made by Warren Buffett’s portfolio managers, Ted Weschler and/or Todd Combs.

So how did KMI perform on its first day of trading (February 17, 2016) after release of Berkshire’s 13F filing?

KMI rose by 10.0% ($17.18 + $1.56), substantially outperforming the market averages.  (The S&P 500 rose 1.7% and the Dow Jones Industrial Average rose 1.6%.)

Thus, the “Berkshire Hathaway Effect” of investors closely following Berkshire’s major transactions continues to be observed as it has in previous quarters and years.    

 
 Posted by at 11:46 pm
Feb 162016
 

Berkshire Hathaway (BRK.A, BRK.B) released its SEC 13F filing for the fourth quarter ending December 31, 2015 after the market closed today.  There were several major changes from the third quarter.

One new stake was established:

(1) $400 million in Kinder Morgan (KMI) (Ted Weschler or Todd Combs)

 

There was an increase in the following:

(1) $450 million in Deere (DE)  (Total Stake = $1.7 billion) (Warren Buffett or Ted Weschler or Todd Combs)

(2) $450 million in Wells Fargo (WFC) (Total Stake = $26.1 billion) (Warren Buffett)

 

There was a decrease in the following:

(1) $450 million in AT&T (T) (Total Stake = $1.6 billion) (Todd Combs or Ted Weschler)

 

There were also smaller increases in Axalta (AXTA) (Total Stake = $600 million) and Liberty Global (LBTYA) (Total Stake = $500 million), and a small decrease in Wabco (WBC) (Total Stake = $350 million).  A small position in Chicago Bridge & Iron (CBI) ($80 million) was eliminated.

 

 

 

 

 

 

 

 Posted by at 7:19 pm
Feb 122016
 

In SEC Form 4 filings, Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) has disclosed that in January and early February 2016, it has added to its stake in Phillips 66 (NYSE: PSX) at prices between $72 and $80 per share.   This additional investment of approximately $1.1 billion ($634 million in early January and $446 million in late January and early February) has resulted in Berkshire owning 75.6 million shares of Phillips 66, or 14.3 percent of its outstanding shares.  Berkshire purchased shares in Phillips 66 in 9 of the first 10 trading days in February. Berkshire’s stake in Phillips 66, at its closing price of $75.20 on February 12, is valued at $5.7 billion and is its sixth largest stock holding.

Since it holds over 10 percent of the shares of Phillips 66, Berkshire is required to report changes to its position on SEC Form 4.  Berkshire first revealed owning over 10 percent of Phillips 66 stock in August, 2015.  This year’s purchases are the first Berkshire has made since September.  It is likely that this additional investment in Phillips 66 was made by Warren Buffett.

 Posted by at 8:50 pm
Feb 092016
 

In SEC Form 4 filings, Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) has disclosed that in January and early February 2016, it has added to its stake in Phillips 66 (NYSE: PSX) at prices of $74 – $80 per share.   This additional investment of approximately $1.0 billion ($634 million in early January and $367 million in late January and early February) has resulted in Berkshire owning 74.5 million shares of Phillips 66, or 14.1 percent of its outstanding shares.  Berkshire’s stake in Phillips 66, at its closing price of $75.44 on February 9, is valued at $5.6 billion and is its sixth largest stock holding.

Since it holds over 10 percent of the shares of Phillips 66, Berkshire is required to report changes to its position on SEC Form 4.  Berkshire first revealed owning over 10 percent of Phillips 66 stock in August, 2015.  This year’s purchases are the first Berkshire has made since September.  It is likely that this additional investment in Phillips 66 was made by Warren Buffett’s portfolio managers, Todd Combs and/or Ted Weschler.

ValueWalk and Investing.com published this blog post.

 

 Posted by at 8:49 pm