As with purchasing firearms, I have a three-day waiting period before posting to this site. (And for the same reason: to prevent an emotional act that leads to my shooting myself in the foot.)
But this week is unique in that I am in the same state as I was three days ago: One, still liking Jimmy’s current album (more on that later this week — this warrants additional scrutiny), and two, deriving actual, if a bit rudimentary, value from Warren’s 1987 letter. For both Buffetts it’s a renaissance here in the mid-eighties. Not unlike [Jefferson] Starship in the actual eighties.
Come on: “We Built This City.” In your head? Give it a second. Yes? How about “Sara?”
Alright, Warren. Let’s do 1987.
Here’s what’s unique about this letter: I think Warren, having run out of diatribes for the time being, felt obliged to revisit some of his core investing principles. So they’re sprinkled throughout 1987 like the cookie dough in my ice cream. Raw, salmonella-laced cookie dough.
Know what I call the Internet? The Triple-Dub.
Buffett starts with a reminder that the fundamental figure — I call this the Double-F — of an asset is its earnings from equity employed. I call that the Triple-E. And in Berkshire’s case, 1987′s Triple-E is Exceptional: its seven major units employed $175 million in equity to produce $100 million in after-tax earnings. That’s a 57% return on equity capital, which Warren assures me is ludicrously amazing. (Is it as amazing as my one-month 42% gain in BP? You decide. Wait, no I will. Nope.)
Warren also mentions debt a few times throughout the letter. Debt plus equity is the basic formula to determine the Triple-E, and “really good businesses usually don’t need to borrow.” He proceeds to rub it in by pointing out that debt among Berkshire holdings is practically nonexistent: interest expenses equate to barely one percent of earnings.
Of course now I wish I’d paid more attention to the debt Smithfield (SFD) carries on its books — little piggy debt… precious trichinosis-laced piggy debt — though I read this year’s nascent efforts to pay down as a positive sign. But, again: what do I know?
WB moves on to break down the financials from each unit, which are outstanding. But he also points out that “there’s not a lot new to report about these businesses — and that’s good, not bad.” Whyever, Warren? Because despite the fervor that often surrounds “exotic-sounding businesses” (cough, Tesla) in WB’s mind the best investments — i.e., the best businesses — are those that are simply doing the same thing they’ve always done. Major change introduces major uncertainty, and often titillates the market, but as Johnnie Cochran might have said, titillation is not value creation:
“Economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.”
(At least I’ve stuck to this one. While I have bought too many equities, and with a lack of logic that itself defies all logic, I’ve bought relatively staid businesses.)
This next section I found completely irrelevant. I’m putting it here anyway. The Buffalo Evening News in 1987 produced seven daily editions (WTF?), and “we redo the obituary page in every edition of the News, or seven times a day.”
WTF?
Warren uses this to underscore the point that the News prioritizes quality — i.e., the relevance of its community reportage, thus its relevance overall, thus its “goodwill” over the long haul thanks to a better consumer relationship — even though fewer editions would improve its bottom line. But to me it raises the question: how many frickin’ people are dying in Buffalo that it needs seven obit updates a day? Berkshire should have bought a Buffalo undertaker instead of its newspaper.
(Oh! I just thought of this: I’d call it the Buffalo Roam Funeral Home.*)
Near the end of 1987 WB describes some things about the stock market that he learned from Ben Graham, his mentor — and inventor of the crackers, probably. There’s a long allegory featuring a character named “Mr. Market” — Ben was not one for creative writing — but the gist is this:
- The market is like the unstable cousin you had to dance with at weddings growing up: “At times (Mr. Market) feels euphoric and can see only the favorable factors affecting the business… At other times he is depressed and can see nothing but trouble ahead for both the business and the world.”
- The market can be ignored. It will be around tomorrow with more quotes. Not acting is a fine choice for today.
- “Mr. Market is there to serve you, not to guide you.” Trust the market to be one thing: manic. So make up your own mind, and take advantage when the market is off its meds.
- “The market may ignore business success for a while, but eventually will confirm it.” Stick to your guns in evaluating a business. Then lie in wait. Like a fox. A leptospirosis-laced fox.
WB claims that this holds true even in the flashy, gadget-rich days of 1987:
“In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace.”
(Of course, this was before the Triple-Dub.)
Warren also uses this point to beat a bit on the institutional investors he blames for 1987′s Black Monday (22% drop in the Dow in one day, holy crap!), through their myopic focus on other investors’ behavior — rather than, uh, hyperopic focus on business behavior — and the resultant automatic stop-loss sales of stock that triggered the crash. Idiots.
And finally, a quote that speaks particularly to me — or would have spoken to me, prior to my BP tour de force: “If you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game.”
Oh, Single-S snap! Dang, Warren!
*If that’s not a song title I don’t know what is. Okay, maybe “Titillation is Not Value Creation.”
