Investing In What We Know and Business Like Investing

Should You Buy What You Know?

Do you like this great investing book The Intelligent Investor ?

What is even more interesting is that billionaire investor Warren Buffett still continues to read this great book by Benjamin Graham and yet the great legendary investor still continues to learn from it!

Under the revised edition by Jason Zweig, Chapter 5, pg 125 (commentary on Chapter 5), there is this one interesting commentary:

Should You Buy What You Know?

Another excellent commentary in which Jason commented that the intelligent investor should not simply abuse any famous investment teaching. Take one of Peter Lynch's famous teachings "buy what you know", in which, Lynch teaches that one can outperform the experts if one uses their edge by investing in companies or industries one already understand. The next step is doing the research. In which accordingly to Lynch, no one should invest in a company, no matter how great its products, without studying its financial statements and estimating its business value.

So how does one abuse this great teaching?

Ahhh... according to Jason, many would only remember and adopt the very first part of the teaching, which is "buy what you know".

The next part of doing the research is sadly neglected by the investor!!!

How valid is this point? Have you seen it happened before? Were those 'investments' a success? Think about it...

Well, Jason puts it very nicely:

In short, familiarity breeds complacency. On the TV news, isn't always a neighbour or the best friend or the parent of the criminal who says in a shocked voice, "He was such a nice guy". That's because whenever we are too close to someone or something, we take the beliefs for granted, instead of questioning them as we do when we confront something more remote. The more familiar a stock is, the more likely is to turn an investor into a lazy one who thinks there's no need to do any homework. Don't let that happen to you.

Don't you agree?

Say you were a frequent flyer with Air Asia from day one and you are a firm believer in that business model. So should you 'invest' in Air Asia because you 'know' the business?

Well, if one had invested in Air Asia from day one (without doing the homework) since its IPO listing back in Nov 2004, such an investment would have yielded a terrible, terrible result considering the general market had enjoyed a remarkable bullish run since 2004.

The below picture shows Air Asia performance since its IPO.

This rather terrible performance from Air Asia is not a shocker for me because I was less than impressed with the way Air Asia gave overly optimistic IPO earnings projections. See Air Asia. And if the investor had done the extra homework, the investor should have clearly seen that perhaps the IPO was simply priced based on sky high earnings projections. Which ultimately means it's probably way overpriced!)

How about Business Like Investing?

Well did you know that fellow blogger, Seng, had once written a great piece on investing called Fundamental Analysis (Do give a good read!)

Let me contribute a bit on Business like Investing or as Ah Seng Kor calls it BA or Business Analysis.

Business like Investing.

Making logical investment decisions is always crucial to one's success in investing. And it has been said that when one invests in a stock, perhaps one should consider it as if one has been given the opportunity to be a part owner of the business itself.

And when one adopts such an approach in their investment, one is forced to make investment decision based on simple logical decisions, decisions which are focused mainly on whether they believe that the stock that they want to purchase, represent a truly quality business in which they would want to be a part owner of such a business.

In short, one should think of being one of the bossie owning the business!!

And logically, if I am gonna be a BOSSIE in THE business, doesn't it make sense that I want to own a really good business?

In all honesty, who would want to own a lousy business?

And how would you rate your chances of making money from an ordinary, average business?

And needless to say, one would seriously not want to be own business with partners who you do not trust. Folks who would most likely cheat you the very second you have your back turned against them?

Put it this way, when we buy any stock, what are we doing in reality? We are buying the 'rights' to be a shareholder of the company, right? And since by the virtues of being a shareholder of the listed company, aren't we virtually the partner or part-owner (in regardless of the size of the shares that we purchase) of the business?

As said by one famous investor, Warren Buffett,

• “Investment is most intelligent when it is most businesslike.”

"We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one

• that we can understand;
• with favorable long-term prospects;
• operated by honest and competent people; and
• available at a very attractive price."

Let's look at a simplistic example.

Ass-u-me and imagine that I own a famous barn yard called, Moo Moo Cow. So

if I were to approach you with a real-life opportunity to make an investment and be my business partner in my barn yard business, what's the first few things that you would be reasoning out?

1. How do we rate this barnyard business?

Do we understand what this cow business is all about? How on earth does one make money in a barnyard? etc etc....

2. Show me the Moola! We then need to know how profitable the business is. This is where we look at stuff like earnings track record, cash flow, profit margins etc etc.

3. And then we need to know what's next. Knowing what has happened before is important but just as important; we would want to know about the long term business prospect of the barn yard business. Got future or not?

4. Business weakness and competitors?

Don't you want to know what's the weakness in this bard yard business? Are there any business competitors from any cousin cows?

5. Do you trust the owners?

Do you trust this moo moo cow enough to be a part owner of this business? Will I attempt to take advantage of you as a business partner by short-changing you in any which way possible? Do you trust me enough?

Do you think that this cow is competent enough to manage your money?

In short, it's all about corporate governance here.

6. And last but not least, how much?

How much is this investment in this barnyard going to cost?

What kind of returns are you looking at when you invest in my barnyard?

And these are some simplistic logical, commonsense rational issues that one would want to consider if one wants to be a business partner of a business.

And if this barn yard is really real and is listed in the stock exchange, when one invest in this cow stock, shouldn't one adopt the same businesslike approach as if one was buying an actual stake in the barn yard?

Here's an old blog posting based on this approach published a long time ago.

http://whereiszemoola.blogspot.com/2006/01/buying-quality-businesses-megan-part.html

Yes, if one had adopted the business like investing perspective, one would have never even considered investing in Megan!!

And here is an article posted on Wallstraits: http://www.wallstraits.com/main/viewarticle.php?id=1202

Share buybacks: Green Packet

I just had a look at Green Packet price.

It was just less than four months ago when I mentioned that this was a stock which was so aggressive with its share buybacks. See previous posting: Update on Green Packet's Share Buybacks

And it appeared that Green Packet had stopped buying back its shares. The following screen shot showed the last announcement it made to Bursa.

Price now is 1.52.

Makes you wonder, why the company was so aggressive buying back its shares earlier?

And yes, here is one stock for your scrap book....

now how would you want to label it?

'Example of why share buybacks fails....

'Don't assume too much from share buybacks....

Is US in a Recession, Technically? Or Is The Mean Season?

Saw the following posting on BigPicture, Technically, Not a Recession

That simple picture spoke a thousand words.

Read the following piece Pinched Consumers Scramble for Cash

• After a long binge of borrowing, U.S. consumers face a credit crunch and a sagging economy. To sustain their living standards, many Americans are doing what comes naturally: scrambling to raise more cash.
  
  Sheron Brunner, 63 years old, bought a $250,000 life-insurance policy in 1997, planning to leave the proceeds to her three children. She faithfully made her $113 monthly payments. But after retiring in 2002 from her job running a homelessness-prevention program, her finances unraveled. Health problems forced her to siphon her savings. A monthly Social Security check of about $700, her only source of income, doesn't cover her medical bills and rising everyday expenses. In September, she moved to Wichita, Kan., from San Francisco to cut her cost of living.
  
  It wasn't enough, so this spring she signed what's known as a life-settlement agreement with J.G. Wentworth, a company that buys life-insurance policies and other tough-to-sell assets. The contract transfers ownership of a life-insurance policy to a third party, which then pays future premiums and collects the benefit. Ms. Brunner received about $45,000 for her $250,000 term policy.
  
  "It wasn't what I wanted," she says. But "with the economy the way it is, I needed that help now."
  
  As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals. Some new fast-cash options allow homeowners to squeeze equity from their houses -- without the burden of monthly payments. One new product offers a one-time payment. In exchange, the company shares in as much as 50% of any future gain or loss in the property's value, typically collecting proceeds when the house is sold.
  
  Americans are resorting to these more extreme measures due to the combination of dwindling jobs, falling home prices, shaky credit markets and a sharp run-up in food and energy prices. Consumer confidence hit a 28-year low in May, according to the latest Reuters/University of Michigan survey of consumer sentiment. Consumer spending and income inched up 0.2% in April from March, but after adjusting for inflation were flat, government data show.

And to make matters worse, them credit card issuers aren't exactly nice: Drowning in debt: Deceptive credit card practices

And John Mauldin newsletter features The Mean Season.

Here are some of the key issues mentioned.

• The U.S. Economy
  
  An array of American industries is beginning to experience deep distress. Three in particular are about to experience a wave of restructurings or defaults that will drive a stake through the heart of the American economy: airlines, automobiles and retailers.
  
  The Airline Industry - Unfriendly Skies
  
  Having tried to merge in virtually every permutation available and failed, the airlines are now left with no choice but to cut capacity and pray for oil prices to fall. American Airlines, generally considered the best managed and healthiest U.S. airline, announced on May 21, 2008 that it will cut its capacity by 12 percent and reduce its workforce by a commensurate amount due to high oil prices (which account for 40 percent of its cost structure).[1] Delta and Northwest, which had the dubious distinction of filing for bankruptcy on the same day, have announced that they will merge (although in the airline industry there is a huge distance between the cup and the lip, so whether this deal is ultimately consummated remains to be seen). United and USAir have been flirting with each other but seem unlikely to mate despite titters that they may try to hook up again. The bottom line is that airlines, which are marginal businesses in the best of times, are unsustainable businesses with oil at current levels. The industry was partially nationalized after 9-11. The current oil spike should finish the job.
  
  The Automobile Industry - One Big Pothole
  
  The automobile industry continues to be weighed down by the albatrosses of outmoded products, unionized workforces, crippling legacy costs, higher raw material costs and the unavoidable conclusion that the world has passed them by. It is both startling and depressing to hear American automakers just now coming to the conclusion that they are still manufacturing too many gas-guzzling trucks and SUVs and too few hybrid and diesel passenger vehicles. Few industries have seen such profound failures of vision and leadership. Ford announced in late May that it no longer expects to be profitable in 2009 and expects to produce 120,000 to 150,000 fewer trucks and SUVs in the third quarter of 2008 than a year earlier, and 60,000 to 100,000 fewer in the fourth quarter of this year than last year. Job losses and plant closings are sure to follow unless current facilities can be converted to manufacture more fuel efficient vehicles. Ford is generally considered the healthiest of the Big Three.
  
  The Retail Industry - Dropping Before They Shop
  
  When you're about to lose your home and you can't afford to fill your car with gas at $4.00/gallon, you're probably not thinking about driving to the mall to spend more of the money you don't have. The U.S. consumer - the one-time engine of global economic growth - is struggling mightily, and retailers are feeling the pain. The year began with a string of smaller retailers throwing in the towel and filing Chapter 11, including several furniture retailers (Bombay, Levitz, Domain and Wickes), Sharper Image, Fortunoff, Harvey Electronics and the catalogue retailer Lillian Vernon. Linen 'N Things became the largest casualty in the sector in May after struggling from virtually the day that private equity giant Apollo Management L.P. took it private to sell more of what nobody wanted. Many other retailers that are still solvent are feeling the pain and making anticipatory cutbacks, including Foot Locker, which has announced that it will close 140 stores, Ann Taylor, which is shuttering 117 locations, and Zales which will eliminate 100. Another Apollo-owned retailer, Claire's Stores, has seen its bonds trade down to distressed levels (although HCM is less convinced that this is a bankruptcy candidate, probably based on the many torturous hours I spent with my daughter Alessia at the Claire's store in the Boca Raton mall).
  
  The Housing Industry - A Monument to Futility
  
  Then there is the housing industry, where the news just keeps getting worse and worse. The Office of Federal Housing Oversight reported that U.S. house prices dropped by 3.1 percent in the first quarter of 2008 compared with the first quarter of 2007. Prices for previously-owned single-family homes fell in 43 states, with California and Nevada seeing 8 percent drops. The inventory of unsold homes also continues to rise to unprecedented levels.
  
  One of the reasons for this is that mortgages are extremely hard to come by in today's market. HCM has heard anecdotal evidence of fully qualified potential buyers of high-end homes in California being unable to obtain mortgages, and we imagine this is illustrative of conditions throughout the country. Foreclosure data is almost mind-numbing. In April, foreclosure filings were up 65 percent year-over-year to a record 243,343 according to RealtyTrac. Not all of these houses will actually enter foreclosure, but many of them will. Finally, the S&P/Case-Shiller National Home Price Index shown in Graph 4 declined by 14.1 percent year-over-year in the first quarter of 2008, compared with a 8.9 percent year-over-year decline in the first quarter of 2007. Consecutive declines of this magnitude reverse increases of similar magnitude earlier in this decade, showing the dark side of the real estate bubble that loose monetary policies engendered.
  
  While the Federal Reserve has lowered interest rates and taken other steps to place a safety net under the housing market, there are scant signs of success thus far. In fact, mortgage rates have not dropped nearly as much as hoped due to deeper problems in the credit markets. The mortgage market has not responded in the traditional manner to the Federal Reserve's sharp interest rate reductions because of structural problems arising from the collapse of securitization markets and the vaporization of liquidity from the mortgage market. As a result, lenders (with a push from the government) have been working with borrowers to keep them in their houses. But the government has yet to come up with comprehensive legislation to address this problem, and the American landscape is increasingly littered with empty houses that are expensive for lenders to maintain and whose physical condition is deteriorating. It is going to take years for the housing economy to recover from its downturn, and it is clear that the sector has not hit bottom yet.
  
  Energy - Sapping the Energy Out of Everything Else
  
  In 2007, it did not require a hurricane in the Gulf of Mexico to push oil to $100/barrel. As the United States approaches another storm season, the picture is far grimmer. Oil now exceeds $130/barrel and the best last hope for a meaningful drop in price appears to be the sharp economic slowdown that high oil prices pretty much guarantee at this point. The International Energy Agency is expected to sharply reduce its forecast for future oil supplies when it completes work on a study it is doing on the industry. For several years, the IEA has predicted that supply would keep up with demand that was expected to reach 116 million barrels a day by 2030, up from around $87 million barrels today. The agency is reportedly now coming to the conclusion, which will warm the hearts of believers of the Peak Oil thesis (like HCM), that it will be difficult to squeeze more than 100 million barrels per day out of the ground over the next two decades. It appears that higher oil prices are here to stay.



(do read the article in full here )

Investing and the Myths of Buy And Hold!

One decent little book on investing was written by Curtis Montgomery, Sun Tzu On Investing by Curtis Montgomery

Applying the timeless pearls of wisdom and strategic insight from Taoist warrior and philosopher, Sun Tzu, this book simply makes great sense for everyone.

To win without fighting is best. Go forth armed without determining strategy, and you will destroy yourself in battle.

Much strategy prevails over little strategy, so those with no strategy cannot but be defeated. Therefore it is said that victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.

To win without fighting is the best.

As Master Sun says, "When you know yourself, you are able to protect yourself."

Ask yourself some tough questions about why you want to invest in stock markets, here's a list to get you started.

• What are my financial goals throughout my life.
  
• Why should i buy stocks instead of fixed deposits, bonds or mutual funds?
  
• Based on my personal/family budget, how much capital can i deploy into stocks?
  
• Do i have the stamina to survive bubble and panic markets?
  
• Do i have the desire to understand businesses and investigate management?
  
• Do i have the patience to wait for business values to be expressed in share price?
  
• Can i emotionally detach myself from the daily market "buzz"?

These are the simple basic commonsense personal financial planning issues mentioned by Montgomery in his book (pg 4).

So why is personal financial planning so important?

Remember the blog entry: Is Market For Suckers?

Let me reproduce what is mentioned in the originating blog again.

• Its amazing how life intervenes. Kids, whatever. its a fortunate few that can just shell it away and never touch it. Your “horizon” hits a dead end when you have to put money into a checking account. I have never seen any investing research that deals with random withdrawls that represents real world. And boy oh boy, if life hits you hard when the market is down, you make a withdrawl and you wont ever catch up.

If you do not plan your financial planning well enough, there is always a possibility that sometime in the future an incident might occur requiring some emergency funding. And if it does happen, would you then withdrawl from the stock market?

And as mentioned in the blog, what if this incident happens when the market is down?

Would the forced withdrawl cause a huge damage to your investment?

Is how your investment could be hampered by your own doing?

You could buy a good stock at a good price, but if you are forced to cut short on your investment before the investment could bear fruit for you due to poor personal financial planning, then the chances of you finding success in the stock market will be severely hampered!

Think of every footy match.. :P

Will it do your team any good if you are forced to play each match with 3 play players short?

Sooo.... if you cannot and do not "know yourself, then how are you are able to protect yourself.?

Yes?

Let me repeat Sun Tzu teaching one more time..

• To win without fighting is best. Go forth armed without determining strategy, and you will destroy yourself in battle.
  
  Much strategy prevails over little strategy, so those with no strategy cannot but be defeated. Therefore it is said that victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.

So what is Investing?

Is it Buy and Hold or Buy And Get Old?

BUY and HOLD.

Two of the most misunderstood simple words in the share market.

For an investor, what is a BUY? here's some stuff for one to ponder.

• Is any stock a BUY?


• Does a have stock have a price where it is deemed a BUY?


• Are all good stocks worth a BUY at any given price?

What is HOLD?

Hold means hold, not letting go.

Is this really applicable?

Once we get a good stock at a good price, do we hold it forever and ever? What if...

• The stock we had bought b4, no longer resembles the same stock. do u wanna HOLD? The papaya tree u planted, which gave u all the juicy and sweet papaya no longer bear fruits, do u still keep (HOLD) the same tree? don't u wanna plant a new one?


• Talking about papaya trees... trees they get diseases.... how?
  What if it contracts a deadly disease, do u just HOPE that things wud get better or are u gonna realise that the tree is a goner? Like in business, if something happens to the business model of the company, and business starts to deteriorate, are u gonna recognise the potential risk in your investment or are u gonna just HOPE that things would get better?


• If someone offers u a ridiculous high price for your prized holding, do u wanna HOLD for the sake of the HOLDing principal or do u wanna take their money? for example, u got a dollar for a nickel, and now someone wants to offer u twenty dollars for that nickel. How? Is it a HOLD or is it a ...


• Now back to that papaya tree. Now if the papaya tree is still consistently giving u loads of papaya, which are still as sweet and juicy as ever, what do u wanna do with it? Dun u want to continue HOLDing on to it forever and ever.... until....

So what you think of BUY and HOLD?

And then there is the myth of long term investing.

The myth of buy and hold .

In the book Bull! by Maggie Mahar she explains how market players were taught to buy and hold their stocks for a longer term based on the then investing bible stocks for the long run by Jeremy Seigel, a professor from the famous Wharton School. (Never heard of Seigel? He's the one that Charlie Munger famously called as Demented during Berkshire Annual meeting in 2006. Charlie's exact words "I think he’s demented. He tries to compare apples and elephants in making accurate projections.")

Folks were made to belief that if you bought a stock and held it long enough,the stock investment would have outperform all other investments.

Seigel used stocks such as Kodak, Polariod, Avon, Merk and Texas Instrument as the example. Dubbed the Nifty Fifty they were the equivalent of the Microsofts of today.

Seigel declared that if an investor bought these stocks and held it long long term (ze buy and hold) near the end of 1972 and held on to November 2001, the investors' return would average out some 11.76% a year. (see why the investing public were seduced so much by this Buy and Hold theory?)

Now Steve Leuthold, a venered Minneapolis money manager, had a research which totally disagreed and contradicted Seigel's view point.

According to Leuthold, Seigel's hypothetical example ASS-U-MEd that an individual who invested in these Nifty Fifty stocks in 1972 had divided his portfolio evenly among the fifty stocks, putting 2 percent of their savings into each company and even if these group of stocks plunge, the investor would still rebalanced their portfolio each month for all these 19 years, cashing out on his profits and then adding money into the losers (fuyoh! Would you accept and follow such an investing strategy? LOL! No wonder good old Charlie reckons that he's demented!) so that each stock position remained exactly at 2 percent.

Well, according to Leuthold (me too), such exercise is 'wholly unrealistic' to imagine that anyone would plow the gains from say Merck back into a loser such as Polariod, Burroughs or Xerox, year after year.

(Ahh.. u see Merck climbed a whopping 382%! .. and according to Leuthold, if this exercise did not include Merk, ie the investor failed to pick Merck into their portfolio, their portfolio in the long run would have sank by 12%. Err stock picking is important mah!)

Leuthold pointed out that from 1972 to 1982 the 10 worst performers in the group lost between 37% and 75%.

With losses that much, the commonsense question is that who would continue to send good money after bad money each month, each year?

(make sense mah! tiok boh? Who on earth would put more money into a stock whose business is losing more and more money each year?)

And Leuthold argued that the investors who bought such stocks in 1972 would surely have been discouraged long before stocks started picking up again in 1993.
And according to Mahar, these investors would probably have dumped their fallen angels, probably at a much lower point than what Leuthold numbers had suggested.

(much of what's written is based on pages 41-42 of the book Bull )

Here is a good review of what Mahar wrote:

How did it happen that the very real risks of investing in stocks were forgotten? Mahar explodes the myth of "stocks for the long run," explaining how the market's promoters crunched the numbers to create the illusion that if an investor stays in the casino just a little longer, he is guaranteed to come out a winner. Casting Warren Buffett in a new light, she explains how a value investor is, in the end, a long-term market timer who understands that success depends on how much you pay when you get into the market -- and when you get out. By putting the bull market of 1982–1999 in a larger historical context, she shows how, over time, longtime bull markets beget longtime bear markets.

The future defies prediction, but the history of financial markets makes one thing clear: markets always revert to a mean. Taken as a single story, Bull! is both an illuminating history and a cautionary tale about investing. Analyzing the economic and psychological forces that drive financial cycles, Mahar shows how an extraordinary influx of cash and credit, combined with the obsessive attention of a new financial media, created a cult of equities. Challenging the notion that stocks always outperform all other investments, she reveals why many of Wall Street's most experienced investors believe that the 21st-century investor needs to throw out the old rule book and make a new beginning as he plans for his financial future.

No investor should keep his or her money in the stock market without first reading this book.

Looking at Warren Buffett Investment in Coke

(Continuing on the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)

The true investor welcomes volatility. Ben Graham explained why in Chapter 8 of "The Intelligent Investor"

There he introduced "Mr.Market," an obliging fellow who shows up every day to either buy from you or sell to you, whichever you wish. The more manic-depressive this chap is, the greater the opportunities available to the investor. That's true because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.

In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs. In contrast, we'll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company's business. After we buy a stock, consequently, we would not be disturbed if markets closed for a year or two.

In our opinion, the real risk that an investor must assess is whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake. Though this risk cannot be calculated with engineering precision, it can in some cases be judged with a degree of accuracy that is useful. The primary factors bearing upon this evaluation are:

1) The certainty with which the long-term economic characteristics of the business can be evaluated;

2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;

3) The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;

4) The purchase price of the business;

5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return.

~~~~~~~~~~~~~~~~

The investor is totally free to ignore the market or exploit its folly.

Timeless advice. What the investor wants or rather the goal of the investor should be to exploit the folly of the market and buy shares of companies offered at irrationally low prices (due to the folly of Mr. Market) provided IF that share of the company is backed by a SOLID BUSINESS.

Paying a cheap price for an average business does not gurantee one success. The success comes from paying a cheap price for a solid business. Pay more, get less, Pay less get more

Simple and such commonsense advice.

The certainty with which the long-term economic characteristics of the business can be evaluated;

That perhaps is one of most important point Warren is saying here and Coca Cola was one of the most used example.

The following is Coke's actual earnings per share since 1983.

Year_____Coke's EPS
1983_____$0.17
1984_____$0.20
1985_____$0.22
1986_____$0.26
1987_____$0.30
1988_____$0.36
1989_____$0.42
1990_____$0.51
1991_____$0.61
1992_____$0.72
1993_____$0.84
1994_____$0.98

The long term characteristics of the business (Coke's) was best desribed as ...

Quote:

What was Buffett able to observe as he studied the long-term business prospects of Coca-Cola that others missed. Buffett's overarching strategic approach to equity investing was baffling to analysts who were focused on tactical market interpretations. Buffett was probably first impressed with Coke's consistent per share earnings growth that spanned a decade.

Looking at the table again, it is extremely clear to see that Coke had a consistant set of earnings and that one could note that it was also growing at a steady rate for the last 10 years. This, according to Warren, was the certainty in which the long-term economic characteristics of the business can be evaluated.

In Mary Buffett's second book, The New Buffettology , she dwelves a lot deeper on this competitive edge and in fact she terms it as Durable Competitive Advantage. (pg 56)

... Warren likes to use the castle-and-moat analogy. Pretend that the business in question is a protective moat we'll call its competitve advantage. The competitive-advantage moat protects the castle from attack by other businesses, such as attempts to lure customers away. It can be as simple as a brand name. If you want to eat a taco Bell Chalupa you have to go to Taco Bell. The same goes that finger-lickin'-good chicken that KFC serves. You want tax advice, go to H&R Block. You want a Bud after work, you have to buy it from Budweiser. Wrigley's controls the gum game. Hershey's is America's favourite chocolate. Coca-cola makes America's best selling soft drink. ... the same can be said of a large town with only one newspaper. If you want to advertise in the paper, you have to pay the raye the paper is charging or you don't advertise. (the newspaper has what is called a regional monopoly.) These companies have a competitive advantage - a brand name or regional monoploy - that enables the business producing the product or service to earn monopolylike profits. Competitive advantage allows these businesses greater freedom to charge higher prices, which equates to higher profit margins, which means greater profts for shareholders. Competiting with them head-on is financial insanity.

Yet for Warren, the presence of a competitive advantage and the resulting consumer monopoly are not enough. For Warren to be interested in a company, it must possess a competitive advantage that is durable. What he means by durable is that the business must be able to keep its competitive advantage well into the future without having expand great sums of capital to maintain it. That last phrase is key, for there are companies that do have to spend great sums of capital to keep their competitive advantage, and Warren wants no part of them.

==> for example, Intel has a competitive advantage BUT it does not have a durable competitive advantage. pg.58..

In 2000, Intel spent over $3 billion on research and development alone. If it doesn't spend the money, its product line becomes completely outdated in a few years. How much money do you think hershey's spend on research and development of new products?

Intel's competitive advantage is dependent on management's ability to create new and innovative products th beat the competition. If management misses a beat, Intel and its shareholders lose the game....

~~~~~~~~~~~~~~~~~~~~~~~~~~~

Warren continutes by saying:

In the 1920s, Coca-Cola first began to transform itself into a global enterprise. For more than 60 years, it has been developing business relationships and investing in a system that today carries an estimated replacement cost of more than US$100 billion. Buffett has noted how difficult it would be to compete with Coca-Cola today, "If you gave me $100 billion and said take away the soft drink leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done."

Is it really so difficult to conclude that Coca-Cola and Gillette possess far less business risk over the long term than any computer company or retailer? Worldwide, Coke sells about 44% of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market. Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power.

Let me bring out another snipet from Charlie Munger's The Art of Stock Picking, in which he talks not on Coca-Cola but instead on Wrigley.

And your advantage of scale can be an informational advantage. If I go to some remote place, I may see Wrigley chewing gum alongside Glotz's chewing gum. Well, I know that Wrigley is a satisfactory product, whereas I don't know anything about Glotz's. So if one is 40 cents and the other is 30 cents, am I going to take something I don't know and put it in my mouth which is a pretty personal place, after all for a lousy dime? So, in effect, Wrigley , simply by being so well known, has advantages of scale what you might call an informational advantage.Another advantage of scale comes from psychology. The psychologists use the term “social proof”. We are all influenced subconsciously and to some extent consciously by what we see others do and approve. Therefore, if everybody's buying something, we think it's better. We don't like to be the o­ne guy who's out of step. Again, some of this is at a subconscious level and some of it isn't. Sometimes, we consciously and rationally think, "Gee, I don't know much about this. They know more than I do. Therefore, why shouldn't I follow them?"

And this is what Munger has to say about Coca-Cola:

The social proof phenomenon which comes right out of psychology gives huge advantages to scale ‑ for example, with very wide distribution, which of course is hard to get. One advantage of Coca-Cola is that it's available almost everywhere in the world.Well, suppose you have a little soft drink. Exactly how do you make it available all over the Earth? The worldwide distribution setup which is slowly won by a big enterprise gets to be a huge advantage.... And if you think about it, once you get enough advantages of that type, it can become very hard for anybody to dislodge you.

Yes, perhaps one could argue that these highlights the importance of branding but with the power of branding, the company is able to have a strong 'durable' long-term competitive advantage over its competitors.

And because of the strong competitive advantage the company has, the individual investor is able to evaluate and access if whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake.

Sounds complicated eh?

Not really. Cos what Warren is saying is that when we invest in a stock over a period of time, we want to able to evaluate the possibility of whether our investment could generate a modest return of investment after deducting taxes (for local investors, this tax issue is a non-issue) and after including the inflation factor.

And in 1989 Warren noted that this stock whose name itself represents one of the greatest brand name worldwide carried on the balance sheet for zero value. A company with strong, consistent profit growth for a long period of time. And best of all, this great franchise was selling for a mere 12-times earnings in 1989. What else could Buffett asked for? As they say, the rest was history! With Coca-cola expanding its franchise worldwide, return on equity grew to 39% by 1990, and then to 56.2% by 1995, becoming ever more efficient as it grew and along with Coca-cola growth, Warren's investment simply grew along with it!

Err... isn't this also a good example of winning when it is easier to win?

All we need to do is just wait patiently for the opportunity to make the killing of a life-time!

Developing A Good Investing Mindset

Blast from past.

There was an interesting review by Chetan Parikh, on Scott Kay's book: Five Key Lessons from Top Money Managers ( Same book as reviewed by Mr.Parikh in his previous write-up: Buying quality businesses at reasonable prices )

Here are snippets from Mr.Parikh's write-up (in dark blue italic):

When you filter out companies based on objective standards, you will likely exclude firms that turn out to be good investments. That is not a problem. You are not trying to develop a philosophy that iden­tifies every good investment; rather, you want to build a philosophy such that every investment it identifies is good. For example, assume the universe of superior investments consists of one hundred busi­nesses. Your selection criteria filter out eighty of those companies, along with thousands of bad ones. As long as the twenty firms that pass muster are quality selections, you have accomplished your goal of constructing a portfolio of winners.

Comments: You are not trying to develop a philosophy that iden­tifies every good investment; rather, you want to build a philosophy such that every investment it identifies is good.

I do strongly believe that this is a good point to remember. One cannot pick and call each and every single big winners in the share market. It is simply not possible. But what is more achieveable is building a portfolio in which ALL the investments are deemed as good.

If you purchase a stock that doesn't meet your buy criteria, how will you know when to sell it? When everyone else decides to sell it? When its price drops a certain percent? A lower price might ac­tually make the security more appealing instead of turning it into a sell candidate. You leave the realm of investing to speculate when you violate your investment philosophy.

Comments: See the issue of not letting the LOW PRICE influence your investment philosophy?

Stocks more often than not will most likely suffer a huge drop in stock prices when their earnings or business fundaments decay.

A purchase in such stock will see the investor 'leaving the realm of investing to speculate'.

And the success of such stock purchase would more likely then not to depend on the bouncbackability of the stock rather than due to fundamental reasoning.

Rather than base their decisions on objective criteria, individuals often buy and sell solely because of the opinions of others, again moving them from investing to speculating. Accepting someone else's analysis is fine if you understand and agree with his or her philoso­phy. However, most people don't know the reasoning behind a rec­ommendation when they embrace it.

Comments: Reasoning behind the recommendation is always more important for me. Not the person recommending it. Not how accurate the person's stock recommendation is. What's most important is the reasoning for investing is not a game of follow you, follow me isn't it?

An investment philosophy anchors your decision making and sta­bilizes your portfolio during turbulent times. It acts as both a map and a compass that provide direction and guide you through stormy in­vestment markets. Great investors do not change what they believe to match whatever is popular. They are willing to risk missing a good investment to avoid bad ones.

Comments: ... willing to risk missing a good investment to avoid bad ones.

Ah, the very issue of Missing a good investment, missing out on good opportunities! It's never a crime isn't it? Not buying a stock would not make you look stupid if you do not understand the risk!

• It's no sin to miss a great opportunity outside one's area of competence. (W.Buffett, 1999 Annual Report)

Think about it.

A trader has their own ways in making their moola. A good speculator simply knows how to speculate and make moola their own way. An investor has their own way too.

Simply put; Your way? My way? High way? No way? It simply does not matter.

Most important is that we go our own way that we know the best (most important key issue here is that we really need to make absolute sure of our way!) and not try to imitate other ways for we might not fully understand the potential pitfalls in other way(s).

Think about it this way.

A fisherman knows best how to fish and a tiger hunter knows best how to hunt a tiger. Do you think it is wise for ze fisherman to ignore what it knows best and embark on a tiger hunting mission?

Wouldn't it simply be better for the fisherman not to be foolish and embark on a bad and deadly venture such as 'whacking' tiggers?

So if you see someone making good making great moola in investing... do try to understand the pitfalls in investing before you decide to embrace it. Vice versa in trading, yes?

And lastly, I think it's good to remember the following:

• Great investors do not change what they believe to match whatever is popular. They are willing to risk missing a good investment to avoid bad ones.

The Lousy Business

(Continuing on the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)

The terrible business

Shutdown of Textile Business

In July (1985) we decided to close our textile operation, and by yearend this unpleasant job was largely completed. The history of this business is instructive.

When Buffett Partnership, Ltd., an investment partnership of which I was general partner, bought control of Berkshire Hathaway, it had an accounting net worth of $22 million, all devoted to the textile business. The company’s intrinsic business value, however, was considerably less because the textile assets were unable to earn returns commensurate with their accounting value. Indeed, during the previous nine years (the period in which Berkshire and Hathaway operated as a merged company) aggregate sales of $530 million had produced an aggregate loss of $10 million. Profits had been reported from time to time but the net effect was always one step forward, two steps back.

At the time we made our purchase, southern textile plants - largely non-union - were believed to have an important competitive advantage. Most northern textile operations had closed and many people thought we would liquidate our business as well.

We felt, however, that the business would be run much better by a long-time employee whom, we immediately selected to be president, Ken Chace. In this respect we were 100% correct: Ken and his successor, Garry Morrison, have been excellent managers, every bit the equal of managers at our more profitable businesses.

In early 1967 cash generated by the textile operation was used to fund our entry into insurance via the purchase of National Indemnity Company. Some of the money came from earnings and some from reduced investment in textile inventories, receivables, and fixed assets. This pullback proved wise: although much improved by Ken’s management, the textile business never became a good earner, not even in cyclical upturns.

Further diversification for Berkshire followed, and gradually the textile operation’s depressing effect on our overall return diminished as the business became a progressively smaller portion of the corporation. We remained in the business for reasons that I stated in the 1978 annual report (and summarized at other times also): “(1) our textile businesses are very important employers in their communities, (2) management has been straightforward in reporting on problems and energetic in attacking them, (3) labor has been cooperative and understanding in facing our common problems, and (4) the business should average modest cash returns relative to investment.” I further said, “As long as these conditions prevail - and we expect that they will - we intend to continue to support our textile business despite more attractive alternative uses for capital.”

It turned out that I was very wrong about cash returns (4). Though 1979 was moderately profitable, the business thereafter consumed major amounts of cash. By mid-1985 it became clear, even to me, that this condition was almost sure to continue. Could we have found a buyer who would continue operations, I would have certainly preferred to sell the business rather than liquidate it, even if that meant somewhat lower proceeds for us. But the economics that were finally obvious to me were also obvious to others, and interest was nil.

I won’t close down businesses of sub-normal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses in prospect. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second; the middle ground is the only position that leaves me comfortable.

I should reemphasize that Ken and Garry were resourceful, energetic and imaginative in attempting to make our textile operation a success. Trying to achieve sustainable profitability, they reworked product lines, machinery configurations and distribution arrangements. We also made a major acquisition, Waumbec Mills, with the expectation of important synergy (a term widely used in business to explain an acquisition that otherwise makes no sense). In the end, nothing worked and I should be faulted for not quitting sooner. I ignored Comte’s advice - “the intellect should be the servant of the heart, but not its slave” - and believed what I preferred to believe.

The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists. Much of the trouble we experienced was attributable to competition from foreign countries whose workers are paid a small fraction of the U.S. minimum wage. But that in no way means that our labor force deserves any blame for our closing. In fact, in comparison with employees of American industry generally, our workers were poorly paid, as has been the case throughout the textile business. In contract negotiations, union leaders and members were sensitive to our disadvantageous cost position and did not push for unrealistic wage increases or unproductive work practices. To the contrary, they tried just as hard as we did to keep us competitive. Even during our liquidation period they performed superbly. (Ironically, we would have been better off financially if our union had behaved unreasonably some years ago; we then would have recognized the impossible future that we faced, promptly closed down, and avoided significant future losses.)

Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses.

The promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industry wide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic.

Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital. After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers.

For an understanding of how the to-invest-or-not-to-invest dilemma plays out in a commodity business, it is instructive to look at Burlington Industries. In 1964 Burlington had sales of $1.2 billion against our $50 million. It had strengths in both distribution and production that we could never hope to match. Also, it had an earnings record far superior to ours. Its stock sold at 60 at the end of 1964; ours was 13.

Burlington made a decision to stick to the textile business, and in 1985 had sales of about $2.8 billion. During the 1964-85 period, the company made capital expenditures of about $3 billion, far more than any other U.S. textile company and more than $200-per-share on that $60 stock. A very large part of the expenditures, I am sure, was devoted to cost improvement and expansion. Given Burlington’s basic commitment to stay in textiles, I would also surmise that the company’s capital decisions were quite rational.

Nevertheless, Burlington has lost sales volume in real dollars and has far lower returns on sales and equity now than 20 years ago. Split 2-for-1 in 1965, the stock now sells at 34 -- on an adjusted basis, just a little over its $60 price in 1964. Meanwhile, the CPI has more than tripled. Therefore, each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends have been paid, but they too have shrunk significantly in purchasing power.

This devastating outcome for the shareholders indicates what can happen when much brainpower and energy are applied to a faulty premise. The situation is suggestive of Samuel Johnson’s horse: “A horse that can count to ten is a remarkable horse - not a remarkable mathematician.” Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company - but not a remarkable business.

My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row (though intelligence and effort help considerably, in any business, good or bad). Some years ago I wrote: “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.” Nothing has since changed my point of view on that matter. Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.

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Charlie Munger has a wonderful essay entitled, "The Art of Stock Picking". It was a truly investment classic and in one of the sections, Munger explained why one should NEVER INVESTS in the terrible business. Here is the snippet of what he wrote.

Do enjoy!

==>

The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you.And most people do not get this straight in their heads. But a fellow like Buffett does.

For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textiles which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old o­nes."

And Warren said, "Gee, I hope this doesn't work because if it does, I'm going to close the mill." And he meant it.

What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business."

And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.

That's such an obvious concept ‑ that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.

Conversely, if you own the o­nly newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.

In all cases, the people who sell the machinery ‑ and, by and large, even the internal bureaucrats urging you to buy the equipment show you projections with the amount you'll save at current prices with the new technology. However, they don't do the second step of the analysis which is to determine how much is going stay home and how much is just going to flow through to the customer. I've never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: "This capital outlay will save you so much money that it will pay for itself in three years."

So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you've earned a return of o­nly about 4% per annum. That's the textile business.

And it isn't that the machines weren't better. It's just that the savings didn't go to you. The cost reductions came through all right. But the benefit of the cost reductions didn't go to the guy who bought the equipment. It's such a simple idea. It's so basic. And yet it's so often forgotten.

Then there's another model from microeconomics which I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead ‑ you're destroyed. It happens again and again and again.

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So what's a terrible business? See Megan: Part VI

1) MARKET RULES: LET WINNERS RUN
One of the most common investing rules you hear quoted is Sell Losers and Let Winners Run, but there are exceptions...

In that article there is a check list of telltale signs of a potential loser ...

Most investors look for the following telltale signs of concern to determine if a particular stock might become a 'loser':

Declining sales quarter-to-quarter and year-to-year
Rising debt levels
Declining profit margins
Rising inventory levels
Changes in regulatory or legal environment
Emerging competitiors or technologies
Rising interest rates
An emerging overall bear market
Events that negatively impact future earnings
Mergers and acquisitions
Management changes
Institutional or insider selling
Dividend cut or elimination
Concerns over accounting procedures

In my opinion, these are the classical tell-tale signs of the terrible business that we want to avoid!

Investing In the Wonderful Business

Another blast from the past.

(Continuing on the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)

The Wonderful Business

Time is the friend of the wonderful business, the enemy of the mediocre. You might think this principle is obvious, but I had to learn it the hard way. In fact, I had to learn it several times over. Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild Kohn, buying through a company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book value, the people were first-class, and the deal included some extras - unrecorded real estate values and a significant LIFO inventory cushion. How could I miss? So-o-o - three years later I was lucky to sell the business for about what I had paid.

I could give you other personal examples of "bargain-purchase" folly but I'm sure you get the picture: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. Now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.

That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken-down nags. Both Berkshire's textile business and Hochschild, Kohn had able and honest people running them. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand.

I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. After many years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.

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Truly a stock investment classic!

Warren Buffett's excellent comments highlights the folly of buying/investing in a company just because the price is cheap.

As commonsense would tell us that the cheap price does not gurantee us anything at all.

What one merely did is one paid for a business at a cheap price but obviously the more important thing is the type of business we paid for!

Buying a lousy stock at a cheap price - is never a sure win thingy.

The lousy could simply get lousier!

Anyway, this is another example of how one could benefit from learning from other people's mistakes. Buffett bought Berkshire because Berkshire was selling at a substantial discount from its book value, got fantastic people managing the company and even has some hidden gems in terms of unrecorded real estate.

So what went wrong for Buffett?

He made the folly of underestimating the poor underlying business economics of the textile business in Berkshire. By 1985 the textile business in Berkshire failed.

Quote:

"I knew it was a tough business... I was either more arrogant or innocent then. We learned a lot of lessons, but i wish we could have learned them somewhere else," he said.

Buffett once joked of Berkshire's textile business that the assets weren't worth what he tought they were, "but the liabilities were solid."

-- Of Permanent Value ( pg 157)

Lesson?

Buying a stock because of a low price versus NTA or low price versus book value is never a sure win thingy.

Berkshire Hathaway is a real example!