Tuesday, April 30, 2013

This Is How You Earn $50 Million

article photo
source: Omaha Times

Yesterday I posted a note about Warren Buffett and the two lieutenants he hired to help him, Todd Combs and Ted Weschler. 

Normally I don't comment on the same article twice, but in this case I thought the picture accompanying the piece was worth another look.

I have pasted the picture of Todd Combs above.  Combs and Weschler took home out-sized paychecks ($50 million +) last year because their performance was so far ahead of the S&P 500.

Here's what the article wrote:

Todd Combs, 42, and Ted Weschler, 51, are expected to receive bonuses exceeding $50 million each based on their investment results in 2012, evidence that they and Buffett made the right choices when they connected....

Today, Combs and Weschler each manage about $5 billion out of Berkshire Hathaway's $88 billion in investments.

Their pay package is no surprise. Both were high-income investment managers on their own before joining Berkshire.

Buffett has said they would be paid salaries of about 0.1 percent of the money they manage, which would be $5 million a year based on a $5 billion portfolio. They also receive “performance pay” of 10 percent of the amount their investments grow beyond gains by the Standard & Poor's index of 500 publicly traded stocks averaged over several years.

In his latest report to shareholders, Buffett said investments by Weschler and Combs in 2012 were more than 10 percentage points higher than the 16 percent returns by the S&P 500. “They left me in the dust as well,” Buffett wrote.


Here's what struck me about the picture of Combs above:
  1. Look at the stack of reading on his desk - this is probably one day's worth of study;
  2. His computer monitor is turned off, with no ticker tape in evidence;
  3. His office is very bare bones;
  4. His feet on on his desk - good investing is about thinking and learning, not athletics.
Ted Weschler has told friends that he does not feel comfortable making an investment until he has studied it for 500 hours, so it would seem that both he and Combs share the same approach.

As does Warren Buffett's sidekick Charlie Munger.  Here's a quote from Munger:

Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts. Slug it out one inch at a time, day by day. At the end of the day - if you live long enough - most people get what they deserve.

I wasn't the only one impressed by this picture.  Blogger Joshua Brown also posted this picture on his blog The Reformed Broker, and added this comment:

Both Ted and Todd already knew how to make money and pick stocks - but what Buffett is teaching them now is how to become legendary.

It begins with getting off the phone, shutting down the monitor, turning off the TV and reading. A lot. Charlie Munger once famously remarked "In my whole life, I have known no wise people who didn't read all the time -- none, zero. You'd be amazed at how much Warren(Buffett) reads -- at how much I read. My children laugh at me. They think I'm a book with a couple of legs sticking out.” It's nice to see that they really live this ethos at Berkshire.


Monday, April 29, 2013

Investing Like Warren

For some investors, the Big Event this coming weekend is not the Kentucky Derby - it's the annual meeting of Berkshire Hathaway in Omaha.

Every year more than 30,000 Berkshire shareholders fans head for Nebraska to attend the "Woodstock for Capitalists", as CEO Warren Buffett calls it.

It's not that there are any burning issues - the actual business part of the meeting lasts for about 15 minutes - but instead it is the opportunity to hear from Buffett and his partner Charlie Munger talk about their views on investing.

The closest I have ever come to attending the meeting occurred a number of years ago.  A client directed me to invest some of his funds in Berkshire.  However, because the purchase was only made about a month before the annual meeting, my client needed a letter from me stating that he was a shareholder, which of course I gladly did.

My client traveled to Omaha and had a great time.  He had his picture taken with Buffett, and as a gift to me, had Buffett autograph my letter to give to me (my brush with greatness!).

To this day, the client will not let me even talk about selling a share of Berkshire, for which I am grateful, since the performance of the stock has been ridiculously good (see chart above).

Buffett's investing record, of course, is probably the best in modern times, and so naturally there is great interest in "how to invest like Warren".

Buffett himself is quite open about his process, and dozens of books have been written about him.  Apparently there is even a bookstore in Omaha called the Bookworm Book Store that specializes in Buffett books, and will do a banner business this week.

The real secret to Buffett's success, in my opinion, is that he is relentless in his pursuit of information and knowledge. 

Buffett's friend and fellow billionaire Bill Gates has said that he is amazed on how open Buffett is able to keep on his calendar.  Most of Buffett's days and nights are spent reading and talking to other investors he trusts, and very little in meetings.

This came out in an article published this week in the Omaha Times.  The piece was focused on Todd Combs and Ted Weschler, who are the two money managers that Buffett hired at the end of 2011 to help him transition some of his investment duties.

Here's the part that caught my eye:

That kind of compensation wasn't on Combs' radar when he first saw Buffett in person. He was among 165 students in a Columbia University investing class.
Combs didn't meet Buffett that day but says, “I still remember it like it was yesterday.”

One of the students asked what he could do now to prepare for an investing career. Buffett thought for a few seconds and then reached for the stack of reports, trade publications and other papers he had brought with him.

“Read 500 pages like this every day,” said Buffett, or words to that effect. “That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”

Remarkably, Combs began doing just that, keeping track of how many pages and what he read each day. Eventually finding and reading productive material became second nature, a habit. As he began his investing career, he would read even more, hitting 600, 750, even 1,000 pages a day.

Combs discovered that Buffett's formula worked, giving him more knowledge that helped him with what became his primary job — seeking the truth about potential investments.


Friday, April 26, 2013

The Can't Win Decision: What To Do With Apple Stock Here

Apple has been one of the most difficult stocks to analyze in my career.

If you had bought Apple two years ago, in April 2011, you would have enjoyed a gain of around +20%, or about in-line with the S&P 500.  Along the way, however, it has been a much more "interesting" ride.

In the first four months of 2012, Apple soared by nearly +50%, and in the process became the most valuable company in the S&P 500. 

Since then, however, it has retraced most of its gains, falling from a high of $700 in September 2012 to just above $400 today.

The problem for any fundamental analyst over the past couple of years has been that the stock always looked cheap on any number of valuation metrics, particularly relative to its growth rate.

Apple's growth has been ridiculously strong; if the revenue estimates provided by Wall Street are at all accurate, for example, for the period ending September 30, 2013, Apple will have achieved a +45% 5-year revenue compound growth rate, and a +64% 5-year compound growth rate.

Cash flow has been "insanely great"; even with management guidance of slowing revenue growth in the coming quarters, Apple will add an additional $55 billion to its $137 billion cash hoard by the end of the year.

And yet the stock is off -43% in the last 6 months.

Today the stock trades a single digit P/E multiple, and will offer investors a 3% dividend yield under the new plan announced earlier this week.

So what to do with the stock now?  With no near-term catalyst apparently in place, but valuation very attractive, the stock has become the ultimate "can't win" story.

I decided yesterday to reduce holdings in client portfolios.  In some cases, where the positions were relatively small, I have exited the position entirely.  I laid out my rationale to my colleagues in the following memo:

I recommend  selling ½  or all of  Apple.   For now I would suggest  leaving the proceeds in cash.

On a quantitative level, Apple’s announcements earlier this week seems to me to at least be an indication that the foreseeable future for the company will be challenging.  The company’s $50 billion stock buyback is huge, but it is mostly offset by lower guidance.  According to Glen Yeung at Citi, net Apple 2013 EPS will only benefit by about +2.6%, and +5% in 2014 and 2015.  And that assumes that GPM goes higher from here.

As we are all painfully aware, Apple continues to look attractive, with a single digit P/E multiple and a dividend yield that will now be close to 3%. This is what makes the buy/sell decision so hard. Frankly, these are the metrics that prevent us from exiting the position entirely.  However, in some ways you can make the case that the P/E is deceiving – it looks really cheap, but almost 20% of its market cap is cash, which you don’t pay a multiple on. Ex-cash, then, Apple trades at 13x – still cheap, but basically a market multiple.

Personally, I don’t know anything more than I read about its new product cycle. But I wonder whether it will still be able to command a very high price for an upgraded version of what people already have.  For example, if you look at the Verizon website, they are offering the iPhone 4 for free (assuming you sign a two year agreement). If Verizon is indicating that ½ of their Apple “sales” in the first quarter were free phones, what does that say about future pricing?

Finally, the chart looks broken, and I don’t get the sense that anyone here would be a buyer right now.  While I obviously wish I had sold last summer, we can only deal with the situation as it appears today.