Friday, March 28, 2014

10x Pretax Earnings! Case Studies: KO, BNI etc.

So, one of the great things about writing a blog is that I get feedback from some pretty intelligent people.  Most of us don't have a Munger to call, but a blog works well too.  If I say something wrong, I'm sure someone would jump in to point it out.

10% Pretax for Stocks Too?
Anyway, I have mentioned 10x pretax earnings or 10% pretax yield as Buffett's valuation measure numerous times here and more than once I've gotten a response saying that this hurdle is for private deals and not for pricing listed companies.  The argument, of course, is that if you buy a stock at 10% pretax earnings, you won't actually earn 10% pretax (due to the additional tax at the investee corporate level whereas in a wholly owned business, a 10% pretax return is actually a 10% pretax return).

It is true that when Buffett speaks of returns in the stock market, he uses GDP growth and dividend yields; earnings can't grow more than GDP and stock returns will reflect earnings growth over time plus whatever dividends you get.

Translating that into individual stocks, you will get earnings growth plus dividend yield equals expected return on the stock.

The only problem with this is that it doesn't tell you what the business is worth.  Would you pay 50x p/e for it?  20x?  The above calculation only works if valuation stays the same.

Anyway, my usual response to this is that many value investors (including Buffett) likes to analyze businesses based on what a rational businessperson would pay for the business in a private transaction.

So, if Buffett is willing to pay 10x pretax earnings for Wells Fargo in a private transaction to buy the whole thing, that is a valuation benchmark for me.  I know that this is not actually possible.  There are size and regulatory issues that will make this unlikely.  But in terms of valuing businesses, I think it is still a useful benchmark.

Is this how Buffett thinks about it? If he pays 10x pretax earnings for WFC stock, he will not necessarily earn a 10% pretax yield.  I don't know the answer to that question. Maybe that's a good annual meeting question.

But as long as I know that Buffett  would be totally happy to pay 10x pretax for the whole business, that's good enough for me regardless of whether that will actually happen.

Yes, you can argue that these "private business transaction" valuations are only valid when there is some chance of a private deal occurring.  But I only think of that when the private valuations don't make too much economic sense to me; valuations per eyeball or per POP valuations in the past, for example, or 40x EV/EBITDA for some media assets, or per acre land valuations etc.; just because some people are paying high prices doesn't mean anything unless there is a real prospect that what you are looking at will also be taken out at some point at the same high level.

Is 10x Pretax Reasonable? 
But 10x pretax earnings, even for listed companies, is not unreasonable at all.  You can translate that 10x pretax into a 15x after tax p/e ratio, and that wouldn't be far off from the 100 year or so long term average of U.S. listed businesses.   Since Buffett buys quality, above average businesses, paying 10x pretax is like paying an average price for an above average business.

So even if my view is wrong, it passes the rationality test; why not pay average prices for above average businesses?  And this is not dependent on market p/e or interest rates because you are using a long term average.  We are not increasing valuations due to decreased interest rates.

Case Studies
So, this discussion piqued my interest again so I decided to go back and look at some more of Buffett's big deals.  I use the term "case study", but it's far from it, really.  I'm only looking at one measure; pretax earnings yield or price to pretax profits.  So I apologize for the exaggerated terminology and to folks who come here looking for a 300 page paper on why Buffett bought something; you'll only see one line.  We all know how great the businesses he owns are, so there really is no need to look at that.

So, I looked at the 2005 purchase of Wells Fargo, Walmart and the recent IBM purchases, but what about some of the other older ones?

Again, since the Warren Buffet Library of Corporate Annual Reports doesn't exist yet, I can only look at some of them.

I got lucky and found a 1988 annual report of Coke, so that's good. Let's start there.

Below, let's take a quick look at Coke (KO), American Express (AXP) and Burlington Northern (BNI) (which a prominent value investing academic said was a crazy/insane deal or some such.  We'll see if it really was a bad price) and some others.

Coca Cola  (KO)
From the 1988 KO annual report:

Pretax earnings:   $1,582 million
Net earnings:        $1,045 million
EPS:   $2.85
Shares outstanding: 365 million
Year-end stock price:  $44.63

From the Berkshire Hathaway annual reports, the cost of KO was:

                     #shares owned           cost ('000)       cost/share (my calculation)
1988 AR       14,172,500                  $592,540       $41.81
1989 AR       23,350,000               $1,023,920       $43.85

So with $1,582 million in pretax profits and 365 million shares outstanding, that's $4.33/share in pretax earnings per share.

So it turns out he paid 9.7x pretax earnings as of 1988 and 10.1x pretax earnings as of the end of 1989.  

That's a pretty stunning discovery, even for me.  I think a lot of value investors were puzzled at what looked like a growth stock purchase by Buffett at the time, but it fits right in with the 10x pretax benchmark perfectly.  He didn't pay up because KO was a really high quality business; he paid what he normally pays.

American Express  (AXP)
So this one doesn't quite fit the mold, but let's take a quick look at it (it doesn't fit only because he didn't pay almost exactly 10x pretax earnings, but far less).

The 1994 annual report is the first time AXP showed up in the BRK letter so let's look at that and what he paid for it:

                        # of shares owned          cost  ('000)          cost/share (my calculation)
1994 AR         27,759,941                     $729,919             $26.29

By the way, I know that this is only an estimated cost per share of the stocks.  There may be some adjustments somewhere that might throw this off, but I don't think it would change things materially.

Thankfully, the SEC database goes back to 1994, so let's pull the relevant AXP figures from 1994:

Pretax earnings:  $1,891 million
EPS: $2.75
Shares outstanding:  496 million

So we don't even have to go very far with this one.  It looks like Buffett paid 9.6x net earnings for AXP.

Pretax earnings per share comes to $3.81/share, so he paid a 6.9x pretax earnings.

It looks like he got AXP really cheaply.   It got pretty cheap in 2009 too.

Moving on.

U.S. Bancorp (USB)
It looks like he started buying USB in 2006, but maybe earlier.  It shows up first in 2006 on the annual report.  He bought more in 2007.  This is from the annual reports:

                     #shares owned           cost ($mn)       cost/share (my calculation)
2006 AR       31,033,800                  $969                 $31.22
2007 AR       75,176,026                $2,417                $32.45

And here are the figures for USB in 2006 and 2007:

              Pretax          diluted (mn)                  Pretax
              earnings       shares outstanding        EPS
2006       $6,912         1,804                            $3.83
2007       $6,282         1,758                            $3.57

2013       $7,990         1,849                            $4.32

So in 2006, BRK was paying 8.2x pretax earings, and the total cost through 2007 comes to 9.1x pretax earnings of 2007.

And interestingly, BRK increased shares held in USB from 78 million in 2012 to 96 million at the end of 2013.  The pretax EPS of USB was $4.32 in 2013 and the stock traded in the range of 7.4 - 9.5x that figure throughout the year.

Burlington Northern (BNI)
So this is one of his other major purchases that made everyone scratch their heads.  There are two things to look at here; one purchase when he just bought the shares and then a second time when he bought out the whole company.  Let's take a look.

The first time BNI appeared in the annual report was 2007.  In 2006, he said there were two positions worth $1.6 billion that was not listed, so BNI was probably purchased in 2006 and other times too (could be some before and some after).

Here is what the 2007 BRK annual report showed:

                       # of shares owned          cost  ($mn)          cost/share (my calculation)
2007 AR         60,828,818                     $4,731                  $77.78

And these are the figures for BNI for 2006 and 2007:

                                                   2006               2007
EPS:                                           $5.11              $5.10
Pretax earnings:                         $2.96 bn         $3.0 bn
diluted shares outstanding:           370 mn        359 mn
Pretax EPS:                                $8.11             $8.25

So from this, it looks like Buffett was paying 9.4x - 9.6x pretax earnings per share.  Voila!

And then of course, BRK bought the whole thing in late 2009 (on an announcement basis).  The offer price was $100, so let's see what the BNI figures were for 2009.  Even though the figures haven't come out yet when the announcement was made, most of the year was over, so they would have known pretty much what the earnings were going to be.

Here it is:

BNI 2009
EPS:   $6.08
Pretax earnings:  $3,368 mn
Diluted shares outstanding:  348 million
Pretax EPS:   $9.68

So at $100/share, Buffett paid 10.3x pretax EPS of BNI.

A lot of people thought Buffett overpaid, but it turns out he just paid what he always seems to pay.  I know, I know.  What about capex, maintanence capex / depreciation and all that?   Yes, that was the argument back then.  I don't know.  I'm just looking at this and noticing a pattern.  I don't have all the answers!

BNI Tangent
What's a blog post here without a tangent?  As I was doing this stuff, I just took a quick look at the famous 'projections' of BNI that was included in the merger proxy.  Buffett has said that he ignores these management projections, but these are often done by management / investment bankers in mergers so they can do their cash flow discount model analysis and whatnot.

So here are the various projections for BNI from the proxy dated December 2009:

2010 Recovery Case

  2009E  2010E  2011E  2012E  2013E  2014E  CAGR
  (In millions, except per share and percentage data)
Total revenue
  $14,013  $14,994  $16,601  $17,611  $18,667  $19,418  6.7
Freight revenue w/o fuel
  12,372  12,830  14,063  15,014  15,834  16,558  6.0
Operating income
  3,204  3,421  4,336  4,921  5,360  5,745  12.4
  4,737  5,052  6,056  6,746  7,313  7,825  10.6
Net income
  1,631  1,717  2,224  2,476  2,663  2,831  11.7
Earnings per share
  4.77  5.04  6.88  8.41  9.71  10.96  18.1
2011 Recovery Case

  2009E  2010E  2011E  2012E  2013E  2014E  CAGR
  (In millions, except per share and percentage data)
Total revenue
  $14,013  $14,254  $15,436  $16,629  $17,839  $18,877  6.1
Freight revenue w/o fuel
  12,372  12,424  13,345  14,291  15,244  16,044  5.3
Operating income
  3,204  3,092  3,638  4,241  4,775  5,209  10.2
  4,737  4,723  5,357  6,063  6,724  7,283  9.0
Net income
  1,631  1,515  1,842  2,149  2,386  2,572  9.5
Earnings per share
  4.77  4.41  5.43  6.74  8.10  9.35  14.4
No Recovery Case

  2009E  2010E  2011E  2012E  2013E  2014E  CAGR
  (In millions, except per share and percentage data)
Total revenue
  $14,013  $14,012  $14,410  $14,622  $14,844  $15,069  1.5
Freight revenue w/o fuel
  12,372  12,377  12,736  12,953  13,176  13,401  1.6
Operating income
  3,204  3,010  3,224  3,324  3,314  3,310  0.7
  4,737  4,639  4,939  5,138  5,249  5,363  2.5
Net income
  1,631  1,465  1,607  1,660  1,631  1,610  (0.3%) 
Earnings per share
  4.77  4.27  4.65  4.87  4.94  5.07  1.2
Deeper Recession Case

  2009E  2010E  2011E  2012E  2013E  2014E  CAGR
  (In millions, except per share and percentage data)
Total revenue
  $14,013  $13,544  $13,618  $14,000  $14,283  $14,756  1.0
Freight revenue w/o fuel
  12,372  12,107  12,147  12,351  12,632  12,929  0.9
Operating income
  3,204  2,759  2,728  2,778  2,841  2,898  (2.0%) 
  4,737  4,387  4,440  4,588  4,770  4,943  0.9
Net income
  1,631  1,310  1,295  1,326  1,369  1,399  (3.0%) 
Earnings per share
  4.77  3.82  3.74  3.80  3.89  4.05  (3.2%) 

And check this out.  These are the figures for 2013 that BNI actually booked (from the BNI 10-K):

BNI 2013 Results
Revenues:             $22,014 million
Operating income:  $6,667 million
Pretax income:        $5,928 million
Net income:             $3,793 million

The most bullish projection in 2009 was for operating income of $5,360 million and net income of $2,663 million.  Operating income came in 24% higher and net came in 42% higher!

OK, so here's one more acquisition.  This name might not give BRK holders a warm and fuzzy feeling (due to the Sokol incident), but it is a major acquisition so it is a relevant data point.

BRK bought Lubrizol in 2011 for $135/share.

For the 2010 year, here are some figures for Lubrizol:

EPS:  $10.64
Pretax earnings:  $1.00 billion
Diluted shares outstanding:  68.8 million
Pretax EPS:  $14.53

So a $135/share purchase is 9.3x pretax EPS.

So let's just recap all of this stuff I said in the last post (part 5) and this one.

These are the multiples to pretax earnings Buffett paid in these big deals:

KO in 1988/89:    10.1x
AXP in 1994:         6.9x
WMT in 2005:      10.3 - 12.9x (range of stock price in2005)
WFC in 2005:         9x
USB in 2006/2007:  9.1x
USB in 2013:  7.4 - 9.5x (range of stock price in 2013)
BNI stock purchase: 9.5x
BNI acquisition:  10.3x
Lubrizol:   9.3x
IBM:  9.7x

I exclude Heinz here as it is a different situation and I think he said he wouldn't have done the deal without 3G.  I may be missing some here as I didn't intend this to be comprehensive by any means, but just looked quickly at some of the large purchases he has made over the years and it is very interesting.

It's amazing how so many of the deals cluster around the 10x pretax earnings ratio despite these businesses being in different industries with different capital expenditure needs and things like that.

Even the BNI acquisition, which many thought was overpriced (crazy / insane deal! Buffett has lost his marbles!) looks normal by this measure; a price that Buffett has always been paying.

And yes, right now I'm the guy swinging around a hammer (seeing only nails), but I notice a pattern and think it's really interesting.

Of course, this actually makes no sense as every company has different capital needs (free cash flow / owner earnings etc.)  Of course, what Buffett calls "owner earnings" are more important than pretax profits.  This was one of the arguments about the BNI deal.

And it is silly to think you can price anything and everything at 10x pretax profits.  Buffett obviously looks at everything else and has a deep understanding of the various businesses and is only willing to pay this amount for the very best businesses out there.

Why he says he will pay 9-10x pretax earnings (OK, for private deals) and yet seems to go out and pay 9-10x pretax earnings on stocks is a good and valid question.

It's amazing, though, isn't it?  Even if it is an odd coincidence.

But I don't think 10x pretax earnings for a stock is a bad price if it's a high quality business that can grow over time etc...  (But you still have to answer the question how much growth there will be and how much a shareholder can expect to get back.)

Thursday, March 27, 2014

Buffett the Market Timer? Part 5: The Berkshire Years 2005-2013

OK, so here we go.  Hopefully this will be the last part in this marathon series.

BRK LTS 2005
So 2005 turns out to be an interesting year.  After years of not doing much in the stock market, Buffett initiates positions in Anheuser-Busch, Walmart, and "substantially" increases his position in Wells Fargo.

It's been a while since he did something major in the stock market, but since 1999/2000 or so, he has been very active in purchasing private businesses; that's where the relative value was, and as he said, even at the same price he would prefer wholly owned businesses.

Anyway, this is exciting because we haven't seen much action in the stock market so these new additions will give us a benchmark (or confirm what we know) in how he values businesses.

Interestingly, here is the background of 2005:  The market has been rallying since the 1999/2000 pop of the Great Bubble, and the market is heading up towards the old bubble highs.  The valuation backdrop was that the S&P 500 index p/e ratio was around 18-20x and the Shiller p/e ratio was around 26-27x, both at the high end of their valuation ranges.  The ten-year bond rate was between 4-5%.

Market sentiment was still cautious due to the recent bubble pop and high valuations.  But this was before the 2006-2007 bubble really took off (even though people were talking about a housing and credit bubble already).

This is hardly the environment for value investors to be active.  The valuation dispersion that we saw in 1999/2000 was not really there in the mid-2000's as I recall.  Value stocks went up as expensive stocks went down, so things seemed more or less fairly valued around then.

Anyway, here are some snips from the 2005 annual report:

WFC Case Study
Let's take a look at Wells Fargo (WFC) first.  I am particularly interested because I have been into banks and we all know that Buffett loves WFC.  He bought WFC back during the banking crisis of 1990, so it is interesting to see him step up and buy a bunch of stock at non-bargain prices.

Here is some information about WFC as of 2005:

BPS:              $24.25
diluted EPS:  $4.50
ROE:             19.57%
ROA:             1.72%
Stock price range: $57.62 - 64.70
Closing price (2005-end):  $62.83

Of course, this is 2005 actual data which was not known during 2005, but since WFC is a stable business, I don't think estimates would have been far off.

We don't even need to go find out how much Buffett paid for WFC since the price range in 2005 seemed to be pretty tight, within $58-65.  Let's take the midpoint of that of around $61.

At $61/share, that's 2.5x BPS!  Buffett paid 2.5x BPS for a big bank not long before the financial crisis.   2.5x BPS sounds like a fantasy now for banks to be valued at.

But let's see what's going on here.  Why would he pay so much?  ROE was around 20%, so that's one factor. With EPS of $4.50, $61/share is 13.6x p/e.

Remember, though, that Buffett said in one of the letters that he wants to pay 10x pretax earnings.  I also remember Charlie Munger at an annual meeting using WFC as a benchmark for valuing potential BRK investments; he said that if they can buy WFC at 10x pretax earnings, why would they look at something else?  Alice Schroeder also said a while back that this is all Buffett focuses on; trying to make a 10x pretax yield.  Buffett also mentioned the 10x pretax hurdle in an annual meeting.

I also made a post not too long ago claiming that Buffett would keep buying WFC right up to 10x pretax earnings per share (see Wells Fargo is Cheap! and 13% and 15% Pretax Returns Now!).

So this is a chance to look back and see how this measure applied during 2005.   Pretax earnings in 2005 for WFC was $11,548 million (ignore minority interest as it's small) and diluted shares outstanding was 1,705.5 million.  That gives us a pretax EPS of $6.77/share.

That means at $61/share, Buffett would have been paying 9x pretax earnings, and was probably willing to go up to $68/share.

So my posts claiming that Buffett would keep buying WFC right up to 10x pretax earnings is not even hypothetical; he did pay something similar to that in size in 2005.

So that's kind of exciting.

By the way, using 2013 figures, let's see where Buffett's limit is for buying WFC.   Pretax earnings were $32,629 million.  From that, let's be more accurate now and deduct minority interest of $346 million and preferred dividends (and other) of $989 million for a pretax to common of $31,294. Diluted shares outstanding was 5,371.2 million so that's $5.83/share in pretax EPS in 2013 for WFC.  10x that is $58.30/share.  So Buffett can pay up to 18% higher than the current price ($49.61/share) and still meet his hurdle! 

JPM Tangent
OK, let me go on a tangent again.  Well, Buffett owns (or did own until recently) JPM so maybe not such a big tangent.

All of the above would also mean, by the way, that Buffett probably sees JP Morgan as worth far more than the current valuation (put a 10x pretax multiple on it like I did in one of the above-linked posts).

JPM had $6.50/share in pretax EPS in 2013 (pretax profit less $1.3 billion in preferreds and other distributions) so Buffett would pay up to $65/share.    But there were some one-time legal expenses too, so let's use the net income of $27 billion from the "earnings power" slide from the 2014 Investor Day presentation.  Pretax, that would be $38.5 billion and less $1.3 billion of that stuff between net income and net income to common shareholders and you get $37.2 billion pretax profits, and with 3.8 billion shares outstanding, that's $9.79/share in pretax earnings power at JPM.

So Buffett would be happy to pay close to $100/share for JPM!  Am I crazy?  Don't look at me.  I'm just doing the numbers.  The proof is there.

What about WMT? 

The figures for WMT in 2005 were as follows:

EPS:   $2.68
diluted shares outstanding:  4.2 billion
Pretax income:  $17,358 million
Pretax EPS:  $4.14
Stock price range:  $42.49 - 53.51

So WMT's p/e ranged between 15.9x - 20x; not so cheap, but on a pretax basis, the p/e ratio was 10.3x - 12.9x.

We see that at the lower end of the range, WMT would have fit the 10x pretax earnings hurdle. I remember he said he regretted not buying more WMT as he was working to buy shares but stopped as the price got away from him.  I don't remember when he said that so don't know if he is talking about 2005.  If he was, then it makes perfect sense, right?  At the lower end of the range, he was paying around 10x pretax earnings.

So now, not only do we have confirmation from Buffett that he likes to pay 10x pretax earnings, but we see him actually doing it back in 2005.

And again, it's very interesting that he was doing this at a time when the Shiller p/e and normal p/e ratio of the stock market were so high.   This is not the behavior of a market timer, but a stock picker with a very specific return target.  Of course, qualitative analysis is very important too; Buffett wouldn't buy just anything at 10x pretax earnings.

Anyway, when I started out this series of posts, I didn't expect to realize this sort of thing (but I shouldn't be surprised; it's just what I would have expected).

Also, he notes that he sees modest returns going forward in the stock portfolio; 6-8%/year over time. But he doesn't sell out despite stocks not being cheap and the overall market being expensive as the expected returns are reasonable (considering long term rates under 5% at the time).

Macro Guy
OK, so in the 2005 letter he does go back to more macro-talk:

It's interesting that as he unwinds the foreign exchange positions, he replaced some of that with purchases of non-U.S. equities.  This is very unlike Buffett.  But I don't think anyone would doubt that he would only do this if these businesses fit the very same mold as his domestic stock holdings.  In other words, he isn't just going to go out and buy foreign stocks just to get non-dollar exposure (like many people seem to do).

It's important to remember that these macro ideas that Buffett does are not major contributors to the intrinsic value growth of BRK and importantly doesn't take away from the productive assets in place.  In other words, he's not going to sell a perfectly good U.S. stock position to replace it with, say, a German phone company stock just to get non-dollar exposure.  Nor is he going to sell the U.S. equity portfolio to buy a foreign exchange ETF, or an emerging market ETF or whatever else the dollar bears usually do.

When you read the advice given in financial magazines, they tell people to allocate assets to this area or  that area so there is no capital efficiency; if you want foreign exchange exposure, people have to sell stock and then go and buy a Japanese Yen ETF, for example.

The way Buffett plays it is that these positions are often just an overlay on top of BRK's assets so he doesn't give up anything in the current portfolio (except maybe some credit). That's a big difference.  He continues to benefit from the existing stocks and assets in place, and then he makes a macro play on top of it where he may make or lose money.  And in any case, the positions are not big enough to cause a lot of harm (these are not George Soro-sized trades).

These are almost like intellectual diversions for Buffett.  It would be a big mistake to try to play crude oil, silver or foreign currencies by saying, "But Buffett does it!".

BRK LTS 2006
Not much stock market activity or comment in 2006, but here's Buffett the macro guy again:

So here he is again talking about seeking non-dollar exposure via foreign equities and U.S. corporations with non-dollar revenues.

He does remind us that the FX factor "is not dominant in our selection of equities, but is merely one of many considerations."

Compare this to some other people with a similar view on the dollar as Buffett.  Some are bearish the dollar but want to spread their bets.  What do they do?  They short the dollar, short U.S. treasuries, buy gold and short the S&P 500 index.   Why?  To diversify.  Hmm...

If Buffett is completely wrong on the direction of the U.S. dollar, how will he do?  (Fine!)

BRK LTS 2007
2007 is the year that things started to fall apart.  There isn't much discussion on it as Buffett had no idea how bad things would get.

So why so complacent?  He has a huge position in WFC already having recently added a bunch in 2005.  As we know, Buffett doesn't get in and out according to macro forecasts, so that's no surprise.  And he doesn't see how bad it's going to get, but that's OK too.  The BRK portfolio is structured so that he doesn't have to see these things coming.   He only invests in the best businesses; businesses that will withstand the worst of times.  And WFC got through the crisis pretty easily. 

Macro Guy Again
So this old man with too much time on his hands in Omaha starts dabbling in derivatives again.  These aren't really macro trades or investments; they are opportunities based on pricing: 

The short puts surprised a lot of people.  And this was again right before the markets really started tanking in 2008 so very poorly timed.  At least he could have gotten better prices in 2008.  But then again, this was an opportunity based on the prices at the time, and it is a 15-20 year position so it doesn't matter if the market crashed the next day, the next month or the next year, just as it didn't matter when Washington Post stock went down 50% shortly after BRK bought into it.  So what happened right after the position was put on is irrelevant.  No matter how much people try, nobody (well, someone always does) ever really buys the low print of a stock on any given day.  Just because you didn't buy the low tick doesn't make a stock purchase a mistake.

And More on FX

I think a lot of this stuff has to do with the fact that there aren't that many stocks for him to look at, and when deal flow gets slow he gets bored and this is what he comes up with.

But again, whatever he is doing is not replacing what BRK is already doing so to that extent, it shouldn't cause any harm.

By the way, Buffett said he has been looking at a weak dollar since 2002, and his last foreign currency position (except Brazilian Real) was gone by 2007.  So that's a nice run according to this chart.

He did say a weak dollar was a certainty or something like that in 2005/2006

This is from the 2002 annual letter; I may have missed it and forgot to place it in Part 4 of the series:

So he put on the positions in 2002 and was out by 2007 so that's a nice trade!  He was bearish in 2007 too but got out due to the increasing cost of carry on the positions.  Since then, it looks like the dollar hasn't done too much.

The key here, again, is that if he was wrong, it wouldn't have hurt him too much (he only made a little more than $2 billion on what looks like a spectacular run in the position according to the above chart), so if he was wrong it wouldn't have been a big deal.

Many shared the same view as him on the dollar, including his thought that the problem could go well beyond the currency markets.  But he played it in a way that wouldn't have hurt BRK too much while many others played it in a way that they would win big if they were right or lose a lot of money if they were wrong.  There's a big difference there.

But yes, it's a macro play nonetheless.    We can argue he plays the macro (because he does), but you can also argue that he doesn't as this stuff isn't a very big value driver of BRK; it's not the primary or even secondary driver of intrinsic value growth there.

BRK LTS 2008
So things really start to unravel.  It's interesting to note that in 2006 and 2007, the Schiller p/e was very high, in the 26-28x range throughout the mid-2000's and regular p/e's were also in the 18-20 range, the highest levels since 1929 excluding the Great Bubble (of 1999), and Buffett never talked about lightening up on stocks.  Despite regretting not selling Coke during the Great Bubble, there is no talk of selling anything throughout this 'expensive' period.

Let's see what he sees in 2008:

Despite all of this, he shows no indication of trying to set up a hedge or anything like that.  BRK is built to survive tough times like this, so there is no talk of having to hedge, lighten up or anything like that.

Here is his view on the market during this scary time:

So he is "certain" that the economy will "be in shambles throughout 2009" and probably "well beyond", but he still insists that "that conclusion does not tell us whether the stock market will rise or fall."

He says they will continue to do the four things they always do, in good times and bad.

I remember at this time the parlor game was guessing who will fall next and how far down the market will go.  People rushed to leveraged bearish ETFs and things like that.  Others who are otherwise 'intelligent' insisted that the market won't bottom until it gets to 7x p/e or probably lower since this crisis is worse than 1982 or 1974.

Anyway, Buffett's game is not to try to forecast these things and get out before they hit and then try to get back in when the coast is clear, but to try to build an organization (and buy stocks of businesses) that will be strong enough that they won't have to predict this sort of thing and try to adjust accordingly; that would be like driving a car and not putting on the seatbelt having the confidence to know when an accident will happen so you can just fasten your seatbelt right before impact.  I know that sounds so stupid, but this is what happens in the markets!

So let's take a look at his activity in 2008:

We already know of his big buys during the crisis; the GE , GS and Wrigley deals.

He does mention his mistake of buying Irish banks that lost value pretty quickly and his error of buying ConocoPhillips stock when oil and gas prices were so high.  He said he didn't anticipate crude oil prices going down to $40-50, but he shouldn't really care about the short term if he is confident crude oil prices should be higher than that over time.  In that sense, it really wasn't a mistake, but only something that looks like a mistake temporarily.

Oh, and is expecting higher crude oil prices over time a macro call?  He is a peak oil believer.  Judging the long term supply and demand situation of a commodity may be more industry analysis than macro call (he is not expecting higher crude oil prices due to stronger than normal economic growth, for example).

But OK, if someone wants to call it macro, that's fine.  I won't argue.

He sold some Johnson & Johnson, Proctor & Gamble and ConocoPhillips stock, but he says that was to fund the purchase of the preferreds; he would have liked to keep them but wanted to keep a rock solid balance sheet with ample cash.  So that's not really a market call or anything like that.

Buy American.  I am. 
In October, 2008, Buffett wrote an op-ed in the New York Times telling people to buy American stocks.  He also said he is doing exactly that in his personal account which until then only had U.S. treasury bonds in it.

This is sort of a market call, but he was just warning people from panicking and getting out of stocks which would be a big mistake.  He points out the non-correlation between economic outlook and stock prices.

But isn't this market timing in his personal account?  Well, not really.  I think his default position in personal portfolio is cash or bonds.  If he is going to spend time looking for investments, his time is better spent looking for something for BRK because his personal account is less than 1% of his net worth.  Why bother even trying to double that if it will only increase your net worth by 1%?

But sometimes things get so silly and out of whack (like Korean stocks a while back) that he just jumps in with his personal funds.  If things stabilize and normalize, he will probably go right back to bonds (well, he thinks bonds are the biggest bubble ever, so maybe not bonds).

BRK LTS 2009
We know Buffett put a lot of capital to work in 2008/2009.  Anyway here are just some quotes:

Stock sales were made to help fund the BNSF acquisition, so it has nothing to do with the market.

And a lot of cash has been put to work:

BRK LTS 2010
People still are shaken from the crisis and Buffett tells us that things are always uncertain, but that things will be fine over time:

Before I move on, let's look at the valuation background of the market during 2010-2013.  This stuff is from the Shiller website so I'll list the Shiller p/e and regular p/e:

Data as of January 1:

                 Shiller p/e           TTM p/e
2010         20.52                   20.70
2011         22.97                   16.30
2012         21.21                   14.87
2013         21.90                   17.03
2014         25.30                   19.30

So you notice that during this time that Buffett tells people not to worry, prices are not necessarily cheap.

BRK LTS 2011
And some major commitments in stocks again in 2011:

So let's take a look at IBM and WFC really quickly.  We know Buffett paid 5x p/e for WFC back in 1990 or so, but then paid 10x pretax profit in 2005.  He added another billion in 2011.  How much did he pay?

Pretax profits in 2011 was $23,656 million.  Subtract minority interest of $342 million and preferred dividends of $844 million and we have pretax earnings to common of $22,470 million.  With 5,323 million diluted shares outstanding, that comes to $4.22/share in pretax EPS for WFC.  The stock traded in the range of $23-$34 and closed the year at $27.56/share.  So WFC traded in the range of 5.4x - 8.1x pretax profits, and closed the year at 6.5x pretax EPS.  Of course Buffett was buying.  What were you doing?

How about IBM?  Doing something similar, IBM had $17.50 in pretax EPS in 2011, and just dividing the "cost" by the number of shares held for IBM in the table of the 2011 annual report, we see the cost of the IBM position is around, guess?  $170/share.  That comes to 9.7x pretax EPS.  Bingo.

If there is any doubt that 10x pretax earnings is his 'hurdle', there should be a little bit less now.  I liked the 2005 WFC example, but it's good to see that the metric hasn't changed for the bank after the crisis as he has been buying after 2011 too.

And keep in mind that when he says he likes to pay 10x pretax earnings, that is not the same as saying that he thinks intrinsic value is 10x pretax earnings.  He likes to pay less than intrinsic value, right?  So businesses he likes are worth far more than 10x pretax earnings.  That's just what he would pay, not what he would fair value something at.

BRK LTS 2012
So finally we get to 2012.  Combs and Weschler have started investing BRK's capital.  Also keep in mind the market levels; the market is by no means cheap at this point.  Buffett didn't tell these guys to wait and don't invest until the market gets to an 8x p/e or 12x p/e or anything like that at all (just like Buffett ignored warnings from his dad and Benjamin Graham when he started in the 1950's).

We also have to remember that Combs/Weschler are outperforming the S&P 500 index by a wide margin, but that's because they are managing $5 billion or $7 billion each.  If they had to take over the BRK portfolio that is now well over $100 billion, they won't be able to outperform by so much.

For example, if they both outperform the index by 10%, that's worth $1.0 - $1.4 billion to BRK.   But if they took over the $100 billion portfolio, they won't be able to outperform by 10%, but they only need to outperform the index by 1.0% to 1.4%/year to give BRK the same dollar benefit.  If they do better than that, of course that's great too.

In any case, Combs / Weschler can do what they do now for a while,  but at some point they may have to evolve into looking for more elephants for them to really move the needle at BRK.  But if anyone can do that, it is probably them.

Here are some comments on the stock portfolio.  He does mention continuing to buy more WFC, which is obvious judging from it's pretax EPS cheapness.

And here's more comments about not trying to time things too much:

BRK LTS 2013
I just wrote up the 2013 letter so I won't repeat it here, but he has a long discussion about investing there and it is pretty much the same as usual.  Don't try to get in and out.  Look at what something can earn, the price you pay and then just let it ride.

So over the past few days, I went through a bunch of Buffett's writings, primarily focused on seeing if he is actually a market timer or not.

My conclusion is that he isn't, really, even though he acts that way at times.  Not buying stuff because things don't look interesting is not really timing as he still has much of the BRK portfolio riding on the line; he is not hedging it out or lightening it up etc.

Here are some random bullet points of thoughts that come to mind after going through all of this stuff:

Market Timing

  • Right from day one in the partnership, against his dad's and Graham's advice not to get into stocks, he displays independence and disregard for market views, even from people he respects. This is not the beginning of a career of a market timer. 
  • Throughout the partnership years, he did go back and forth (in weighting) between general issue holdings and workouts leaning more towards workouts when markets were expensive.  This is not so much market timing as much as moving assets to where they have the best prospective returns.  I think of market timing more as people who get out and sit on cash to wait to get back in, buy puts or put on some other hedge etc.
  • He did liquidate the partnership in 1969, right at the top.  This was obviously partly because the markets were too high.  But on the other hand, he was trying to beat the market by a wide margin and that got harder and harder to do.  I don't know if Buffett would have recommended to people to sell stocks just because they are expensive if someone had a portfolio of stocks they liked.  He did hold onto his BRK shares and bought more, I think, in the early 70's and never sold a share.  He also said that he wanted to slow down, so the unwinding of the partnership was sort of a transition phase for him. 
  • In his last letter to his partners, he saw potential returns in the stock market of 6%/year.  He noted that bonds for the first time offered the same prospective returns as stocks, though. And he did recommend an equity manager (Ruane). This expected return isn't too different than what he said before; early on he saw prospective returns of 5% in stocks and kept running his partnership for many years thereafter. 
  • Even in BRK (in 1970), he sold all marketable securities with no further plans to buy any in the future.  The sale was to fund the purchase of a bank.  After the purchase there were other areas to deploy capital, so although market valuation may have been a factor here (no doubt a big one), it may not necessarily be the main driver (Buffett wanted to buy whole businesses more than stocks). 
  • He bought a bunch of stocks throughout the 1970's responding to the bargain prices. But this isn't really market timing either as he was just responding to market prices that are cheap.
  • Note that he was very aware of inflation and it's ill effects on stocks.  And yet, he kept buying stocks.  This is no action of a market timer.  He even went so far as to question the validity of the legal structure of a bond (sort of a Buffett version of "Bonds are Dead" proclamation, I guess).  But he kept buying stocks.  
  • Later in the 1980's, 90's and 00's, he also responds to prices by not buying stocks for lengthy periods.  He buys more private businesses, and holds cash and bonds when nothing else is available.  But it's interesting to note that cash levels are not held for very long (he always needs to hold some cash) as capital is eventually deployed somewhere. 
  • This is an important distinction to make:  Buffett will insist on bargain or reasonable prices and a margin of safety to buy a stock, but that is not required to hold a stock.  For permanent holdings, he would not think of selling even if it got substantially overvalued.  Most market timers will sell or get out when prices are no longer attractive or reasonable (and wait in cash.  It's not market timing to get out of something priced reasonably to buy something cheaper).   I think this is an important point and one reason why Buffett has done so well over the years.  Like he says, what if something you like gets fully valued and you sell?  Then what do you buy? You will have to buy something just as good at a lower price.  And if you don't?
  • Buffett would not have his record if he sold out of stocks every time he thought the market or even his holdings was fully priced.  He did regret not selling Coke, but if he sold Coke during the Great Bubble, what other things could he have sold that wouldn't have been good idea?
  • He did say markets were too expensive in 1999 and warned people against expecting 20%+ returns over time.  But this was also not an alarm bell that a crash was coming.  I think he would still have advised people to own an index for the long term as he said he still expected returns over time of 6%/year.   If you sell stocks, then what do you buy?  He is not one to tell you to wait for a correction and get in cheaper later.  At most, he will tell you to gradually buy in over time so as not to put everything in at the very top which would make you feel like an idiot. 
  • And he did say Buy American in 2008.  This was sort of a market call, but more a warning to people who were rushing out of stocks in panic.   Also, it was based on sentiment and pricing; he warned people that there is no correlation between economic outlook and stock prices.

  • So, yeah, Buffett had crude oil, silver and foreign currency positions.  He is short long-dated index puts and he was watching crude oil prices when investing in ConocoPhillips.  But these were never really going to drive (or destroy) value at BRK.  Who knows what else there have been that we don't know about!
  • The important thing to remember is that he didn't "tilt" his portfolio over the years according to his macro views.  Most of these things were overlay positions at low cost that had little impact on BRK's other businesses.  The way other typical funds would 'play' these macro themes (and hurt themselves) would be to 'tilt' portfolios to be exposed to these various factors (buy exporters to play weak dollar etc.).  Individuals would buy bear funds or FX ETF's (funded by selling some stocks or other holdings which is very capital inefficient).   
  • He never let his macro views get in the way of BRK's main businesses; they had very little impact on BRK's other businesses and stockholdings. 
  • If he was wrong, BRK shareholders would have hardly noticed.  Funds with the same view as Buffett that hedged out their equity exposure or bought puts most likely noticed some impact on their returns (if the manager was wrong).  Again, the folks at DRCVX (see here) had the same view as Buffett with respect to the U.S. dollar but had very different investment results over the years.
Anyway, this was a very interesting exercise for me.  Of course, I don't think Buffett is a market timer or macro trader, but if someone wants to call him either or both of those, that's fine with me.  That's not that important. 

The important thing is to learn from Buffett and understand why he did so well over the years while most others tend not to do so well.  There is a lesson here, but I'm sure others will take away different things than I do and that's totally fine too. 

Anyway, wow, what a flurry of posts over the past few days.  This is not going to be normal, of course; I can't keep posting at this pace.  I'll go back to my more normal pace soon. I have to admit to being semi-obsessed with getting this done in the past week, sometimes not even reading the day's newspaper until late at night.   

From now on, back to normal for me!