Warren Buffett’s Possible Shopping List

Bloomberg published an interesting article today speculating what Mr. Buffett might buy in this market.

According to Berkshire's 2008 annual report, the shopping list criteria includes:

(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

And Bloomberg uncovered the following companies:

Aetna	Chubb	Kohl’s	Smith International
Aflac	Computer Sciences	Loews Corp.	Southern Copper
Agilent Technologies	Covidien	Marathon Oil	Southwestern Energy
Allergan	Danaher	McKesson	St. Jude Medical
Anadarko Petroleum	EOG Resources	Newmont Mining	Staples
Aon	General Dynamics	Noble Corp.	Sysco
Archer Daniels Midland	Halliburton	Noble Energy	TJX
Baker Hughes	Hess	Nucor	Union Pacific
Becton Dickinson	Illinois Tool Works	Precision Castparts	VF
Brown-Forman	Intercontinental Exchange	Raytheon	WellPoint
Bunge	Intuit	Reynolds American	W.W. Grainger
Cardinal Health	ITT	Rockwell Collins	Zimmer Holdings
Carnival		SAIC

In the article, it stated:

There are 50 U.S. companies with that much market value and profit, a return on equity exceeding 10 percent and a debt-to- equity ratio less than 50 percent...Sysco, VF and Danaher are also the sort of easy-to-understand businesses that Buffett favors.

Among the companies meeting the criteria, 12 have price-to- earnings multiples of no more than 7. They include Houston-based Marathon Oil Corp.; Aflac Inc., an insurer based in Columbus, Georgia; and steelmaker Nucor Corp. of Charlotte, North Carolina.

According to What Has Worked In Investing, published by Tweedy, Browne Company LLC, stocks with low p/e ratio have a higher probability in future price appreciation.

Low Price in Relation to Earnings -
Stocks bought at low price/earnings ratios afford higher earnings yields than stocks bought at higher ratios of price-to-earnings. The earnings yield is the yield which shareholders would receive if all the earnings were paid out as a dividend. Benjamin Graham recommended investing in companies whose earnings yield was 200% of the yield on AAA bonds. Investing in stocks that are priced low in relation to earnings does not preclude investments in companies whose earnings are expected to grow in the future. To paraphrase Warren Buffett, “value” and “growth” are joined at the hip. A company priced low in relation to earnings, whose earnings are expected to grow, is preferable to a similarly priced company whose earnings are not expected to grow. Price is the key. Included within this broad low price in relation to earnings category are high dividend yields and low prices in relation to cash flow (earnings plus depreciation expense).

TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box

Mr. Buffett is on the Squawk Box again giving his opinion and outlook on the stock market.

The whole segment (Part 1-7) is under an hour. Interesting to watch and see how Mr. Buffett remain very much upbeat after many of his holdings suffered substantial decline in 2009.

ASK WARREN BUFFETT 2009

Current DateTime: 07:03:57 10 Mar 2009
LinksList Documentid: 29598432

• Warren Buffett to CNBC: Economy Has "Fallen Off a Cliff"
• LIVE BLOG ARCHIVE: Ask Warren Buffett on CNBC's Squawk Box
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 1
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 2
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 3
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 4
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 5
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 6
• TRANSCRIPT & VIDEO: Ask Warren Buffett on CNBC's Squawk Box - Part 7
• Berkshire's Bank Stocks Boosted By Warren Buffett's Bullish Outlook
• Obama Spokesman: Warren Buffett Was Criticizing Washington, Not the White House
• Ask Warren Buffett 2009: Download the Complete CNBC Transcript

Lecture materials that might be applicable to real world?!

So I am sitting in a random Starbucks as usual wondering off my mind here and there, while squeezing in some studying time on my upcoming exam.

I haven't checked the CBOE volatility index (definition here), but we are in some pretty wacky environment with S&P hitting new lows since 1997. There are a number of experts predicting the S&P could go down to 600 or 400, and on top of that the negative feedback loop is going full speed across consumer and business spending sectors (I have to admit I am one of the herd that asked my family to delay the upgrade of a newer, shiner, and much bigger LCD TV as opposed to the 27" 15 years old tube TV that currently sits in the living room).

I don't know how low the market will go, but I would like to share some of the lecture materials in my CFA studying that hopefully can provide you with some encouraging information about our doomed financial market. Stock prices has been known as one of the leading economic indicators, and the earning power of the underlying firms plays an important role in determining which direction the stock prices might go.

To estimate earning power, there are three different methods suggested by the lecture:

1. Estimate net profit margins based on recent trends
   
2. Estimate net profit before tax margin
   
3. Estimate operating profit margin, which is defined as the earnings before interest, taxes depreciation, and amortization (EBITDA) margin percentage

The book argued that estimating EBITDA is the best method because this measure is before interest, taxes, depreciation, and amortization, so it will provide more stable estimates of net profits than the other two methods.

Taking it word for word, we also examine the factors that may affect EBITDA estimates

1. Capacity utilization - There is a positive relationship between profit margin and capacity utilization. As production increases, there should be a decrease in per-unit fixed costs because costs are spread over a greater number of goods
2. Unit labor costs - There is a negative relationship between unit labor costs and operating profit margins because labor costs are the major variable costs of a firm.
3. Rate of inflation - There are three possible effects that an increase in inflation can have on profit margins, they are either positive, negative, or indifferent. Usually it's a negative relationship because firm faces elastic demand for its products and will not be able to fully pass on the inflation to its customers

In addition, these relationship are also influenced by the business cycle. Immediately following a recession, capacity utilization will be low and utilization will increase sharply as the economy recovers. Labor will also not be bargaining for pay increases at this time so there will be small increases or even decreases in unit labor costs. Thus, profit margins increase greatly in the initial stages of a recovery.

Every recession is different, and the one we currently face is on a global scale for the first time. The drop has been deep and severe with no recovery visible in sight. However, we are currently two years into the financial crisis, and one has to wonder how much more can the overall market decline in the next two to five years. We are close to a point where prudent businesses face favorable factors to increase their bottom line, yet they are currently traded like their junked competitors (Berkshire Hathaway comes to mind).

"If you like it at $50, you will like it at $40, if you like it at $40, you will love it at $20", the people who try to sell you technical trading platforms/strategies usually say it sarcastically. The price argument is very misleading from a technical or fundamental buy and hold approach. The current stock price is just a scorecard that the market assigns. It is the underlying business that only matters.

Just because I paid something for $50, it should not influence my future decision on the price I am willing to pay. Examine the business as you were the owner, and I am sure you will be more comfortable with the recent plunge. If the business's prospect has deteriorated, and it was doing well in the last couple years only because of leverage and/or credit boom, realize our mistakes and get rid of its shares. The probability of poor business to recover is much lower than a better business. It will be a painful lesson, but mistakes provide us with valuable lessons and aid us to become better investors.


(All materials are from 2008 Kaplan Schweser CFA level III Books, and I don't own Berkshire Hathaway shares)

Lectures from Columbia University on Value Investing

http://valueinvestingresource.blogspot.com/2008/05/lectures-from-columbia-universitys.html

Great lectures and I would recommend any stock enthusiast to view them. What's better than great education for free?

Christopher Browne, one of my favorite investment guru who wrote the "Little Book of Value Investing," has two lecture videos in this series.

The follow are some of his speech that I tried to rephrase:

- At the end of the day, management totally counts and it's really the intangible thing that is hard to figure out

- You just have to do the hard work trying to figure out what is the business plan

- Exit business when you believe they are close or above what your research tells you. But if it's an exceptional business, it is worth hanging on as you would as a private business.

- You should view your investment as buying a share of the business, whatever the stock market does should have no influence on your decision

- Buying stock has a lot of similarity to buying a piece of real estate

Charlie Munger - Art of Stock Picking

Who is Charlie Munger? From Wiki:

Biography

Although Munger is more famous for his association with Warren Buffett, Munger ran a very successful investment partnership of his own from 1962 to 1975. According to Buffett's famous essay, "The Superinvestors of Graham and Doddsville", Munger's investment partnership generated compound annual returns of 19.8% during the 1962-75 period compared to a 5.0% annual appreciation rate for the Dow.

There are many insightful words in his letter, I am picking out a few that is against conventional wisdom:

When Warren lectures at business schools, he says, "I could improve your ultimate financial welfare by giving you a ticket with o­nly 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And o­nce you'd punched through the card, you couldn't make any more investments at all."

He says, "Under those rules, you'd really think carefully about what you did and you'd be forced to load up o­n what you'd really thought about. So you'd do so much better."

Again, this is a concept that seems perfectly obvious to me. And to Warren, it seems perfectly obvious. But this is one of the very few business classes in the U.S. where anybody will be saying so. It just isn't the conventional wisdom.

To me, it's obvious that the winner has to bet very selectively. It's been obvious to me since very early in life. I don't know why it's not obvious to very many other people.

I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, "My God, they're purple and green. Do fish really take these lures?" And he said, "Mister, I don't sell to fish."

Investment managers are in the position of that fishing tackle salesman. They're like the guy who was selling salt to the guy who already had too much salt. And as long as the guy will buy salt, why they'll sell salt. But that isn't what ordinarily works for the buyer of investment advice.

If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they're currently paid ‑ because you'd be holding a block of Wal-Mart and a block of Coca-Cola and a block of something else. You'd just sit there. And the client would be getting rich. And, after a while, the client would think, "Why am I paying this guy half a percent a year o­n my wonderful passive holdings?"

So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.

Banking crises, retailing downturn and stretched consumers

The Globe and Mail recently published two interesting articles outlining the Canadian retailing market condition and its consumers' profile. With so much negativity in the media, it is hard to find any silver lining with the global stock markets.

History is not a perfect indicator, but it's worth noting that value of any stock market is usually based on future expectations and fundamentals in the long term. More importantly, high media pessimism predicts downward pressure on market prices followed by a reversion to fundamentals.

I thought Canadian banks and consumers are more disciplined than its south boarder partner, the United States.

However, it's interesting to note that:

[In Canada,] ratio of household debt to disposable income has soared to 130 per cent, moving past that of the United States.

In the meantime:

Outstanding credit card balances, have risen to $80-billion, up 40 per cent since 2004, and delinquent payments - those late by 90 days or more - are rising.

And:

Bankruptcy filings by consumers soared 51 per cent in December from the year before, Industry Canada said earlier this week. In all, 8,299 consumer and business bankruptcies were filed in December, compared with 5,659 a year earlier.

Canadian consumers in general:

“We are seeing changes in our customers' shopping habits,” said Caryn Lerner, chief executive of Holt Renfrew. “We're seeing a shift in brand preferences and in price point preferences. People across all levels of spending have pulled back.”

She said consumers don't want to be too overt in wearing pricey labels, and instead prefer understated outfits. To respond to the shifting tastes, Holt's is stocking its shelves with fashions that are less flashy. And it's trying to get shoppers in the spending mood with a complementary cappucino or bouquet of flowers.

The efforts are in response to sales that fell “in the single digits” over the past six months at the privately held retailer, Ms. Lerner said. She expects similar results this year. “Canadian retail has held up reasonably well,” Mr. Rosen [CEO of Harry Rosen] said.

Over-leveraged public companies are taking a beating right now because their financial imprudence, and its no difference to these individuals that are feeling the same pressure when economy took a severe downtown.

Consumerism has been the primary GDP growth factor since post-war. It seems that we are getting to a point with too much wants and over supply of goods, compounded by easy credits. I believe there is a good chance that the slowdown in consumer spending will bring an economy havoc that is bigger than any of the current issues such as the banking crises, sub-prime mortgages, stock market meltdown, and devalued asset classes.

Confidence is a big issue, and governments around the world are looking for ways to restore it at all costs. I hope consumerism can held our last leg up, but we could be living in the most difficult economy environment in the last 25 years. I do believe profits can still be achieve with business owners, but critical structural reform is needed for a better future. However, governments around the world are still sticking to the same methodology with the same group of decision makers that we have in the past. It's hard to get excited about any of the stimulus plans because they are similar to what was done in the past, only with more debt.

As an individual, there is no better time than now to recheck your financial score card. Those who stayed prudent and living within their mean will have ample opportunities down the road to find attractive bargains in all asset classes because others are forced to liquidate. Now it is not too late to start the preparation and be ready for the next 2-5 years.

This time around, the rush to bankruptcy gets a lot faster

Purveyors of luxury goods, services start to tiptoe down-market

Intelligent Investing Transcript with Jeremy Grantham interviewed by Steve Forbes

An awesome friend send me this interview transcript with Jeremy Grantham at forbes.com.

Who is Jeremy Grantham?

Here is a brief description from Wikipedia.

Jeremy Grantham is the Chairman of the Board of Grantham Mayo Van Otterloo, an American investor well known among institutional investors, but relatively unknown to retail investors. He is regarded as a highly knowledgeable investor in various stock bond and commodity markets. Grantham started one of the world's first index funds in the early 1970s and currently manages approximately $120 billion US.

Mr. Grantham is well known as a great skeptic and holds a bearish view on the market since 1999. He is beginning to add equity position because he sees the market being cheapest in 20 years, speaking on a relatively basis. He believes the market is cheap, but not "very cheap" as it did in 1982 or 1974.

Jeremy Grantham Yes, I would say two-to-one, by the way, my instinct plus looking at the history books, that it will go to a new low [in 2009]. So this is the problem; we're underweighted still. In an ordinary asset allocation account that has 65% in equities, we have moved up to 55%. So, we're still underweight, even though they're cheaper than they've been, and they're reasonably cheap.

Now what happens? If we throw in the client's money and it goes down, indeed, as I think it will [in 2009], they will complain quite bitterly that we weren't very smart. We thought it was going down, and yet we threw their money in. So that's one kind of regret. And the other kind of regret is that we hang back and the market runs away, the one-in-three comes up and they say, "You told us the market was cheap. You told us that you had these 9% or 10% real return opportunities, and you're still underweight and the market's back up 200 points. You're an idiot."

So, there's no way you can avoid some regret. You have to look at your own personal balance sheet. How much pain can you stand? If you absolutely can't stand a 20% hit, you'd better carry quite a lot of cash, because you're quite likely to get it. If, on the other hand, you're made of steel, you can concentrate on the seven-year horizon and filter money in, and having a lot of cash here is probably a bit dangerous from the other point of view.

But in any case, it's a very personal judgment of risk avoidance and how tough you are under stress. The worst situation that will befall probably quite a lot of people is that they exaggerate their toughness. The market goes down 30% from here to 600 and they panic, dump their stocks and never get back. And that's the worst outcome.

He also made some interesting comments on China and Japan:

Jeremy Grantham It's taken them [Japan] 17 years to lose 78% of their money. This is what I say: That exhibit is called "stock for the very, very long run." Aimed at Jeremy Siegel, if you think that people are machines, then of course you can tuck stocks away and hold them forever. But ordinary human beings don't like to wait 17 years to lose 78% of their money or 28 years to round trip in Japan.

They haven't made a penny in 28 years, including dividends, in real terms. And people have dismissed that, "That's Japan, we're the U.S." And that is, in a way, the most simple minded of logic. Of course, every country is different. But do not think that we can't have terrible times. I sincerely hope we will not, and I don't expect that we will. But you have to consider it a possibility.

And on China:

Jeremy Grantham They have a very small consumer sector, so it's hard to stimulate that. A very large capital spending sector. How low does an interest rate have to get to build another steel mill when there are seven up the road empty, not operating. It's not an easy situation, I think. Direct spending on roads and so on is something that might work.

But can they do it big enough, since they're already doing it at a dramatic level? Can they increase it enough to rev their economy? I don't think so. I think their economy will be very flattish for a while. And that will be a bitter shock to everybody who's learned to depend on them.

2009 US stimulus spending package

[Update 1] The spending package has decreased to $317 Billion as agreed to in the Senate on February 6th. The most substantial change was a decrease from $79 billion to $39 billion in the State Fiscal Stabilization Fund, and a $20 billion elimination of the education modernization, renovation, and repair for public schools.

CNN.com has a very nice interactive chart for the proposed US economic stimulus spending (excluding tax cut provisions). US senators are debating with a revised plan that has an additional $40 billion spending to $391 billion, while the overall package decreased from $825 to $819 billion. [Anyone else lost track of the numbers with all the financial catastrophes, it seems $40 billion is a chump change now?]

This is the biggest government stimulus spending in the US history, and I thought the one in 2008 was big (it was purely rebates & tax incentives with a price tag of $152 billion).

Innovative Technology Loan Guarantee Program in energy alone is 1/8 of the proposed spending ($50 billion). Other big ticket items include $79 billion for State Fiscal Stabilizing fund (the name doesn't sound good), and $27 billion for Federal Highway Administration.

Where will it end? No one knows, but the mentality right now is we have to do something than nothing. "Save for a rainy day" seems like an obvious time tested advice, yet it seems we have forgotten that collectively as individuals, corporations, and even governments in the western world.

One-on-One with Warren Buffett - CNBC

http://www.pbs.org/nbr/site/research/learnmore/090122_buffett/

The Extended Interview

Portions of Susie Gharib's interview with Warren Buffett will air in the January 22nd & 23rd broadcasts of NBR. The complete interview is available below. Yoru can also read the complete transcript.

S&P's Monthly Report World By Numbers - Jan 2009

http://www2.standardandpoors.com/spf/pdf/index/WBN_Jan09.pdf

The world markets was slaughtered in 2008. It's no news to anyone but the number is still quite something to observe.

Overall, the world markets tracked by S&P saw the overall market cap declined by $15.5 trillions from $34.9 trillions in Jan 2008 to $19.4 trillions in Jan 2009. The decline is enough to pay for all the US public debt and sent every US citizen a $16,000 check.