I also have a responsibility to these guys. Don't we all?
Yeah, still here.
Back when I jogged there was a saying: “go out hard, die like a pig.” (It’s probably still a saying.) The point was that if you start out too fast, you’re… liable to die squealing on an electrified killing floor?
That can’t be it. Stupid quote. Why not “afterburn out, burn out after?” Or “go out sprintin’, come in limpin’?”
The point is I’ve maintained too great a clip here. Warren and Jimmy are exhausting. And the past two weeks I’ve dreamed of nothing but turning this project into sweet slices of Buffett bacon. (Smithfield-processed, no doubt.)
But, ultimately, I have a responsibility to my readers. No, not you. My future readers. Specifically my kids. Because one day they’ll end up Googling their father, find this project — unfinished — and discover that Dad is a quitter.
They don’t need to know. So: onward we go, at a conversational pace. The kids can learn about me later, from another project I abandon. But first they’ll learn some glib, superficial finance “lessons” from decades past.
Just like you. (See how I did that?)
Let’s go.
Warren’s problem in 1988 is one we can all relate to in 2010: too much stinking capital. (Or is that just how I feel with my BP purchase? Shazam!) Thanks in part to a 20% return in 1988, Berkshire to maintain a 15% annual return over the next decade will have to profit $10.3 billion. (Recall that the same 15% annual return rate of starting capital back only in 1984 would necessitate profits of a mere $3.9B.)
WB uses this point to highlight some subtleties around corporate accounting — specifically the creative ways in which, let’s call them lying jerk companies, ensure that their “earnings” always rise — and that GAAP (generally accepted accounting principles) never sufficiently tell the whole story of a company. Warren’s advice, yes actual advice, to investors is to seek three answers (beyond GAAP) from company financials:
“(1) Approximately how much is the company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?”
Also, “(4) Ever seen a grown man naked?”
Why couldn't I have done the Brothers Zucker???
(True story: on a plane recently my son was invited into the cockpit — pre-flight, of course — and idiot I am I was unable to restrain myself from asking him that question aloud. For whose benefit? His? Of course not; he’s never seen Airplane! The pilots’? My own? What’s wrong with me?*)
Warren gives the usual overview on Berkshire’s amazing holdings — all of which are the apples of his large, apple-stuffed eye — and a lengthy description of the insurance climate. It’s all mildly interesting, but this blog isn’t about mild interests, it’s about action.
He takes an opportunity though to contrast the phenomenal performance of his own managers with that of many CEOs. Lots of paragraphs to make a simple point: CEOs are routinely bad, but hard to fire — for lots of reasons (board coziness; amorphous measurements; no true accountability; handsomeness). It’s a more specific way to reiterate his investing principle to know and trust thy management team.
As a non-MBA-wielder I also enjoyed Warren’s aside about Berkshire’s lack of managerial age limits:
“We do not remove superstars from our lineup merely because they have attained a specified age… Moreover our experience with newly-minted MBAs has not been that great. Their academic records always look terrific and the candidates always know just what to say; but too often they are short on personal commitment to the company and general business savvy. It’s difficult to teach a new dog old tricks.”
Arbitrage
WB has a section on arbitrage, a subject about which I knew nothing — and probably still know nothing, only now I no longer realize that. Anyway, in 1988 Berkshire-cum-arbitrageur netted $78M pre-tax from $147M invested, a return that would make one sit up and take notice if one hadn’t fallen asleep reading this section on the train. (These are 1988 dollars, I remind you. In 2010 dollars it’s approximately ninety-one trillion.)
Anyway: arbitrage at its simplest is buying and selling something in different markets and taking advantage of any discrepancies between the market pricing. But in more modern use it means taking advantage of an “announced corporate event such as sale of the company, merger, recapitalization, reorganization, liquidation, self-tender, etc.” Berkshire’s big win of the year was a good, mildly complicated example:
- Arcata (printing and “forest products” company) is owed some money from the government and currently embroiled in a legal battle around how much exactly.
- KKR (leveraged buyout firm) agrees to buy Arcata for $37/share plus 2/3 of the eventual government settlement.
- Warren has to make a bet on whether a) the deal will happen at all, b) it will happen at the agreed price point, c) it will happen on time, and d) the battle with the government will bear any fruit. Lots of ambiguity.
- Ultimately: BRK accumulates 7% of Arcata at prices from $33.50 to $38; the KKR deal stagnates but another buyer swoops in at $37.50 per share; the government lawsuit settles in favor of Arcata at five times the initial amount. Long story short: the effective sell price per share: $66.98. Not. Frickin. Bad.
Your crib notes on what to ask when arbitrage appears:
“(1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire – a competing takeover bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?”
Warren then drives home a point about the Efficient Market Theory (EMT), a stupid one that says the market is always correct in establishing price/value. Warren’s counter is his fat bankroll: his decades-old track record (and that of his teachers before him) of consistent successful arbitrage declare that while the market may be “reasonably efficient most of the time,” it is clearly far from perfectly so. In the 63 years he tracked his small group’s behavior, the market returned just under 10% annually; Warren’s cronies exceeded 20%. The difference between 10% and 20% from $1000 over 63 years ago? The market: $405,000. Warren: nearly $100 MILLION.
Daaaaamn. EMT? I think you need an EMT — to shock you back to life. Wooo boy.
Just like this blog — probably a couple more times. (See how I did that?)
Out for now. Roger, Roger.
* The first officer loved it.
