Wednesday, June 25, 2014

Warren Wednesday: H2 1962

Warren's letters are starting to grow in size and you can tell with his writing that he is getting used to reporting and giving updates...

H2 1962
Written: January 18, 1963
Length: 13 pages
S&P return for 1962: -11.81%
Buffett's return for 1962:  +13.9%
Major events: Marylin Monroe dies. Nelson Mandela is arrested for incitement to rebellion. Cuban Missile Crisis.

I find it humorous that Warren talks about people wanting his annual letter to be shorter. I guess 7 pages a year is too much to read for someone making you ridiculously rich especially this year where he absolutely demolishes the markets. Tripling them over a 6 year average

He goes over (again) some basics that there are no guarantees of returns, problems of taking out monthly payments etc. The same warnings he gives each year. He also reviews his numbers compared to two big investment funds which he also beats handily. He talks about the power of compounding interest which after having read the Snowball where he tells his kids not to sell their shares, I have to take this as a warning to the monthly payment partners.

Alright now for something we in the 21st century can use... how he breaks down his portfolio.

1: "Generals":  Regular investments where Buffett has no say on the boards.
5-6 positions of 5%-10% each
10-15 positions of smaller size. 
But isn't Warren famous for saying only invest in your 6 best ideas because the 7th one won't make as much money. THIS is exactly why I wanted to read his letters. Separate the sound bites and quotes he gives to general public. What is he thinking and do with his own money.

2: "Work Outs": Companies that take some corporate action to be profitable. Selling of assets, merger and acquisition, spin off.

5-10 positions.
Interesting comment her by Warren...
I believe in using borrowed money to offset a portion of our work-out portfolio, since there is a high degree of safety in this category in terms of both eventual results as well as intermediate market behavior.
He will borrow 10%-20% of the partnership's assets up to 25% maximum. He mentions 5% interest rates. Boy who wouldn't kill for some of that right now in ZIRP.
I don't know if this strategy would work in this day and age. Taking a loan to buy stock with the hope of them being bought out or spinning off a new company. To me it seems way to risky in this day and age.

3: "Control" Companies that he is working on buying out or just activist investing in. The smallest category and one where he says will take years to play out.

     Next he talks about the highlight of 1962, Dempster Mill Manufacturing Company. Dempster made farming instruments, water supplies, and well equipment and Buffett owned 73% of the company. His dollar cost average was $28 and he calculated book value as being $35. You really aren't going to find many companies under book these days but I think we can do something similar with P/E ratios in evaluating undervalued companies. I've owned a few 3 P/E ratio companies in the past.

     So Warren tried to work with management to get them to start being profitable instead of lagging sales and low inventory turnover. They didn't so he put a man named Harry Bottle in charge. By the end of the year the book value had risen to $51.
     I am not entirely sure but from the sound of it he turned the financials around and got an unsecured loan. Still had $16 a share worth of manufacturing but the $35 left over was financial which they then used to by more "generals" stock of other companies. 

He repeats a section that he had in a previous year that I think is critical and will repost it...

You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you. In many quarters the simultaneous occurance of the two above factors is enough to make a course of action meet the test of conservatism.
You will be right, over the course of many transaction, if your hypotheses is correct, your factors are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason
He next goes into discussion of total return isn't his goal but in beating the market. He did have one section of wording that really stuck out to me...
Our job is to pile up yearly advantages...
Note he didn't say his goal or job is to make a lot of money. Or buy cheap undervalued companies. Its to get advantages. This pleases me because its something I have tried to focus on in my own investing. An advantage to me is a reason why the company will outperform others. 
It could be a 5%-10% yearly share buyback rate that gives management a big cushion in growing EPS. (SWY, AAPL, STX)
It could be hugely undervalued (CIG, AFL, AFSI)
It could have a high but staple yield that you can get profit from that regardless of what the share price does (ARCP, PSEC).
Though I am in no way comparing myself to Buffett, just that I am happy to be thinking along similar lines as he did.

Warren ends his letter with some personal call outs and general miscellaneous discussion.

Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial adviser, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.


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  2. Nice post Pulling! About borrowing money with the "Work Outs" I wonder if he did this when the companies announced publicly with their plans like a spin-off or asset sells. I have noticed a quick run up on stock prices then they settle to make another run near the actual event takes place. Good advice and examples with the advantages yearly.

  3. I agree with you that the "work outs" have an element of speculation that you typically don't associate with Buffet. I guess it goes to show you it's not necessarily just the best businesses with the best management that can derive a good return, but having an eye to value wherever it appears can be a path to strong returns.