Wednesday, May 13, 2015

the missing manual: Berkshire Hathaway / Warren Buffett

New Book?! 
OK, so there isn't really a book with this title.  I was just having some fun.  Don't waste your time Googling or Amazoning it.  It doesn't exist. In this day and age, you can't always believe what you see.

But you know, this is exactly what I was thinking as I was reading through some of the comments coming out of the annual meeting.

There were some tough questions raised this time and some shareholders didn't seem pleased with the answers.

Also, not too long after that, a hedge fund manager criticized Buffett calling him a hypocrite.  He apparently backtracked later and said he was only kidding. I think he made these comments because Buffett, at the annual meeting, disapproved of the pretend reinsurance companies; reinsurance was just a 'front' (beard) for what is actually a hedge fund.

I think the criticism against Buffett was a response to that comment.

Anyway, I thought I'd just chime in on what I think about these respective issues that came up.  I don't think I have much to add to what has already been said somewhere on either side of each argument; these are just some thoughts that came to mind as I read about them. Plus, it's an excuse to post this fake book cover I made to the public.

Clayton Homes
One issue was about the lending practices of Clayton Homes.  I read the article (that reported on lending abuses at Clayton) and searched online for complaints and there are some horrible stories there.   Buffett responded that there have been few complaints to his office, few investigations and fines in a highly regulated business.  Clayton sells something like 30,000 homes per year so that says something, how few complaints there are.

I found one Better Business Bureau (BBB) site that shows 172 complaints over three years, but that's only one region.  I don't know what that figure is nationally.  Other websites have nightmare stories about Clayton too, but that doesn't really tell me anything.

If you Google even your favorite restaurant, there will be a few horror stories.  The only problem is that it is a lot more likely for people who had a great meal to write a review on how great their experience was than for people who buy manufactured homes and had a great or normal experience.  The review sites for manufactured homes tend to be nightmare sharing sites.  For me, I need to know what the total figures are, not how bad the few horror stories are.   As far as I'm concerned, Buffett gave those figures.  He said he gets no complaints and has had very little regulatory problems.  Plus the fact that they keep the loans on their books is pretty important; they retain the risk.

Also, we have to keep in mind the nature of the business.  I don't even trust your average real estate agent.  I think they are mostly full of it and don't believe what they say; they'll say what they need to say to get the deal done (well, apparently bond traders do that too!).  Of course there are good and bad agents, just like anywhere else.  I tend to believe that most people are honest, though, and try to do the right thing.  A few bad apples won't spoil it for me (e.g., despite all I heard from the financial crisis, I still like and respect Goldman Sachs).

With respect to problems with the product itself (the homes), I was warned a long time ago by a real estate lawyer in NYC to avoid new construction.  She has done many real estate deals over her long career and in most new constructions there were problems.  It takes a few years for the building to get debugged, and possibly some lawsuits to get the repairs paid for by the developer.  She said let others deal with that headache and just find something that has been working fine for a while already.
So it's kind of not surprising reading about Clayton complaints on the product.   I hear about problems all the time on just about every other construction/renovation etc.  With big projects, there are going to be problems.  This is not a business like delivering pizzas, books or CD's.

In any case, for me to worry about Clayton, there would have to be real numbers, not just a few anecdotes here and there.  There has to be reason to believe that this is an actual, widespread, systemic problem and not just a few problem situations here and there.

This is not to say that we shouldn't question these things.  It's good that this question was raised and Buffett answered them.  It seems like a lot of people were not happy with his response, but I don't know.  He seems to have brought some facts and figures with him so I'm OK with that.

3G Capital
The other concern was that Buffett is getting involved with 3G Capital, a private equity firm.  Buffett has answered this question before, explaining that 3G is not like other private equity firms.  Other private equity firms do things for short term profits.  They need to maximize value and then realize it in five to seven years, so they don't have the long-term horizon that Buffett likes.

3G Capital buys to hold and to grow, not to flip after a few years.  The private equity business model is usually to buy something on leverage, cut costs and boost profits and then sell out (not all private equity firms are the same so I understand not all fit this description).  Cynics will say that the idea is to sell out on strong earnings at a high multiple before the drastic cost cuts start to impact the medium to longer term outlook of the business.

3G Capital doesn't do that.  They buy to own and build.

One journalist still couldn't get around the fact that 3G boosted earnings so quickly at Heinz.  He was confused with operating for the long term while boosting profits in the short term.  He thought, apparently, that they were mutually exclusive.  This is not the case at all.  Just because you boost earnings in the short term doesn't mean you are managing to optimize short term profits and not thinking long term.

If you buy a two-man business that is losing $500,000 / year and notice that you have one guy doing nothing but slurping cup noodles all day long (with no plans to do anything in the future) taking home $1,000,000 / year in salary and fire him, you will improve earnings from a $500,000 loss to a $500,000 profit.    Yes, this improves short-term profits, but it doesn't mean it was a bad long-term business decision. It is probably the right long-term thing to do too. (Well, in this case, there would be no long term without firing that guy!).

Buffett used the example of the railroad industry and farming; right-sizing is necessary in capitalism or else we'd all still be living on farms.  Munger used Russia as an example as an alternative to right-sizing (Russian laborers pretend to work and the government pretends to pay them).

I have another example, and that is the Japanese economy.  Japanese companies too are highly averse to right-sizing and they have paid a heavy price for it.  I read a few books a while ago on the growing problem in Japan of the "working poor", an increasing underclass of poor people in Japan.

The scary thing about this class of "working poor" is that many of them are highly educated former employees of large companies or owners of small to mid-size companies.

What happens is that the companies are so averse to right-sizing that when a firm ultimately and inevitably fails, the employees are unable to find work and end up in minimum wage jobs (working in a convenience store like a Seven-Eleven is apparently common).  Suddenly, these people who drove Mercedes and BMW's were working the cash register on the night shift at the local Seven-Eleven.

The problem with middle management is that much of the time, the skill set acquired at one company is useless anywhere else.  Middle managements often have no skills to bring to other firms.  So when you don't right-size, you have a potential disaster in the making.  Plus, when nobody down-sizes, there is no active labor market.

Jack Welch used to say that firing people is doing them a favor, and keeping them on the payroll when they shouldn't be is bad for them and for the economy.  It sounds mean and harsh, but having seen what's going on in Japan, he is so exactly right.  The sooner excess labor is let go so they can go acquire a new skill or new job, the better.  If you wait until everyone gets too old and then have to fold up the shop, it's too late;  employees will have been doing nothing for too many years/decades to be of use to anyone else.

So anyway, I have no problem with how 3G Capital operates, and I actually think it is good for the economy.  This labor fluidity is necessary.

As for Buffett being involved in this sort of thing, he owns large stakes in companies that are highly efficient.  His private businesses are businesses he bought because he liked how they are run.  There is no inconsistency there. I think Buffett appreciates it when Wells Fargo and American Express (and others) right-size when necessary (so that massive layoffs all at once becomes less likely).  And they have been doing that for decades.  Again, no inconsistency.

Some people think that Buffett is missing the boat on the trend towards healthier lifestyles.  I sort of feel that way too.  But Buffett has a good point.  We've been here before.  He said that there was an article calling for the end of Coke in the 1940's, I think.  People were unhappy with his purchase of KO in 1988.

Trends do come and go.  We've had these health booms in the past.  I remember some of them.  At one point, people were avoiding carbs like the plague.   And the hottest restaurant concept these days is Chipotle Mexican Grill (burritos and tacos, and yes, for those Atkins holdovers, bowls).

Red meat was evil not too long ago, and now we have a huge hamburger boom, Shake Shack just being the latest in this trend.

There was some discussion about IBM too during the annual meeting.  It is interesting that the argument against IBM is that their mainframe business is dead and that they won't be able to catch up with the cloud.  Buffett/Munger pointed out that IBM has been through technology cycles before and has come through fine.  They used to dominate punch cards, but that business doesn't exist anymore and they evolved to the next thing.

The key is the client base, and Buffett seems confident from his discussions with CEO's that IBM clients are going to stay IBM clients for a while.  And he has a pretty good sampling, just within Berkshire Hathaway and the stock holdings.

Also, I haven't done any work, but I rarely hear discussion about IBM's consulting business; somewhere within that beast (or dinosaur) is the old PWC Consulting, and Accenture is a listed company with a 20x P/E ratio.  I don't know how that figures into the argument, but it must fit in there somewhere.  It's not just about mainframes versus cloud, I don't think.

Moving on...

Buffett Ran a Hedge Fund!
Moving on to the "Buffett the hypocrite" thing.   Buffett often criticizes hedge funds (and private equity funds and investment banks too).  He criticizes them for their high fees.

Well, yes, Buffett ran a hedge fund too but he didn't take a management fee.  He only took incentive fees above 6%, I think, with no catch-up provision.  He takes 25% of gains above 6%, so if the fund returned only 6%, he would have gotten nothing.

The standard these days is 2 and 20, which is 2% management fee and 20% incentive fee.   With expected return in stocks, at most, of 10%, that's a lot.  If a fund returned a gross 10%, the net return to the investor would be 6% (before tax!).  So the hedge fund manager would be taking home 40% of the gain.  With Buffett's structure, a gross return of 10% would result in a net gain of 9% for the investor.  Not a bad deal.

Also, Druckenmiller called people who invest in funds with a 2 and 20 structure "idiots" or something like that.  He didn't criticize the funds, but the investors.  He said that during his time in the industry, hedge funds with that kind of fee structure were expected to earn 30-40%/year (or something like that; maybe he said 20-30%).  And he pointed out that they were expected to do well in good markets and bad markets.  He says it's nonsense when managers earn low returns but tout returns on a "risk-adjusted" basis.

But going back, Buffett criticizes the high fees and also the fact that most funds don't perform well.  Buffett's record as a hedge fund manager is well-known.  He had incredible returns and a much friendlier fee structure.

So as far as I'm concerned, there is no hypocrisy here at all.  His fee was fair, and he performed.  For the record, I don't have a problem with hedge funds or their fees.  I think it's up to investors to vote with their feet.  If a manager deserves the high fees, fine.  If not, the investors are dumb.  So what?  Hedge fund investors are presumably either professional institutions or accredited, "sophisticated" investors.  I have more of a problem with products marketed to retail, with fees layered upon fees, much of them hidden (annuities) etc... (12b-1 fees, loads, management fees for perpetual underperformance etc.)

Buffett is/was an Activist!
True that, too.   He has been involved in some situations, but it seems like they were reluctant situations and he didn't like hostile situations.  I think he backed away from things that seemed hostile a long time ago.  Otherwise, yes, he will still be involved in situations where he thinks he might be able to help.  He was active behind the scenes at Coke not too long ago, for example.

But I think the beef he has with activism these days is that they seem to be too short-term oriented; lobbying companies to make moves that will boost the stock price in the short term so that the activist can sell out at a profit.  I think his views of the GM situation earlier this year shows exactly what he didn't like about activism.  If Berkshire Hathaway is an example of his activism, it's a great one; he still owns it after all these years!  I think he has acknowledged in the past that some activism is good.

I too think it's good to a point.  When most shares are held by big mutual fund companies and those mutual fund companies run the 401K plans of the companies they own shares in, I think that might lead to problems.  I think someone has to occasionally step up for the shareholders and rattle the cage a little bit.  I guess the debate would be more about where you draw the line.  Which activist situations were good, and which ones were bad?  DuPont recently is a good case study (I have no opinion either way other than to say that it is interesting!).

Buffett Doesn't Pay Taxes but Wants Others to Pay More
This is one thing that keeps coming up over and over again and it's really annoying to me.  They say that Buffett is calling for higher taxes for the rich and yet he does all he can to avoid taxes.  They say, if he wants the rich to pay higher taxes, why doesn't he just pay more taxes himself?  Let him pick a fair rate and then pay that himself to the government.

I never understood that argument.  It is ridiculous.  Buffett's idea is to raise revenues for the government, and one person like Buffett paying voluntary taxes is not going to move the needle.  (well, some will say that taxing the rich won't move the needle either).

Here goes a bad analogy, but it's like saying, hey, if you want the whole country to lose weight and want to implement limits on the size of soft drinks, just limit soft drinks for yourself!   Well, great.  Limiting soft drinks for yourself might help your own health (possibly, but according to Buffett/Munger, maybe not!) but will do nothing for the country.  I don't mean to debate if this would work anyway.  But the point is, if you want to make a change for the country and advocate policies, you can't just do something yourself and think that will solve the problem.

Buffett's tax thing is like that.  He pays all the taxes that he is required to pay.  He has donated most of his wealth to charity and avoided a huge tax bill, but I don't even know if that was his primary motive to give to charity.  He was clear from early on that he didn't want to give his kids too much money.  The alternative is to give to charity, which happens to be tax free.

For the record (who cares what I think?), I am no advocate of higher taxes.  A much better idea would be to have 3G Capital run the government.  They don't have to become president; they just need to run the operations; Post Office, Amtrak, and everything else!

So anyway, I know all of these things are big topics of debate and I can't say who is right or wrong. I just posted what I personally think about these things.


  1. Thanks, I enjoyed the insights on right-sizing/3G a lot.

    I believe that because Buffett has become so widely followed figure that he does watch out what he says.

    He knows really well how journalism works so he most likely wants to format his message in a way that it doesn't spin out of control, especially regarding the whole "rich people commenting on taxes" matter.

    He probably believes that he can make a bigger difference by accumulating more wealth and then donating all of that to charity instead of accumulating less due to taxes. In the meantime he can do what he likes the best.

    I haven't seen any of his opinions (not following that closely) on government spending, but I'm sure he has some.

    1. "He probably believes that he can make a bigger difference by accumulating more wealth and then donating all of that to charity instead of accumulating less due to taxes"

      Many people think this way, so why not let them act on their beliefs? It's easy to remove other people choice by taking their money (presumably "becauce they are making smaller difference"; btw who decides that?) while retaining it yourself. And advocating such solutions is a little bit hypocritical, don't you think?

    2. Either I phrased it bad or you misunderstood. I was just speculating on his thought process, not what he should or should not do.

  2. I value your analysis usually, but here it seems you are a little bit biased or did not really think these things through (FYI: I don't agree with Buffett critics on all things and have been huge Buffett fan for years; but after all these years I can say he isn't saint; and can be full of it if it suits him/is profitable).

    Eg. your arguments about taxes: one individual such as Buffett may not solve goverment's problems by paying more, however whole Berkshire, with all subsidiaries etc. might move the neddle a little bit (it's quite large isn't it?). And concerning argument about Buffett not paying taxes - I am sure if one wanted to make all people to lose weight then losing weight himself doesn't solve the problem. But it shows at least some sincerity in one's beliefs. And it would be rational first step. Have you ever seen celebrity fitness instructor who is obese? Same with taxes - start with yourself and we will see what's next (and at least we see you are serious). If not, you are a hypocrite and a despotic one at that (not to say potential tyrant - it's easy to impose on others "for their own good" what you wouldn't apply even to yourself; starts with taxes and ends with who knows what).

  3. Hi,
    I agree with you about the trainer; but I don't think people who call for higher taxes should voluntarily pay higher taxes themselves. I understand your thought process, but it still seems nonsensical to me. Regardless of his thoughts on tax rates, he should just pay whatever tax he has to pay. Paying what you owe doesn't preclude you from expressing your opinion freely and you don't have to overpay taxes to gain the right to call for higher rates.

    But again, that's just my opinion and I know many people don't agree and that's OK. This is what makes a market!

    Thanks for dropping by.

    1. The "why don't just pay higher taxes then" criticism of Buffett makes no sense to me.

      I like to play games, and sometimes the rules are unfair. I might say "look, the blue pieces are worth 2 points and that's completely imbalanced, they should only be worth 1 point!", but do you really expect that I'm going to count only 1 point for the blue pieces while everyone else counts 2?

  4. Anonymous posted a comment; I got an email update but it didn't post here for some reason (maybe it will show up with a delay, but sometimes this happens; I get an email saying a comment was posted and it doesn't show up). So just in case, I will cut and paste it here. Anonymous said:
    As Buffett previously wrote : it is a newspaper test ! (

    Yes. BRK is right keeping the loans on their book. And yes it is normal that the loan are highly priced (if they priced less for the loan, they would have been bankrupted like so many other MH companies).
    But :
    The main problem is in my view that from a fair customer point of view, there is a need of independent checks in between the buyer and the seller of the Manufactured house and the seller of the financing. Or more radically, forbid a MH builder firm to also be a financing company !
    "There are also some unique aspects to this buying process, too. In a conventional home purchase, real-estate agents have a duty to represent the interests of the parties involved. A lender would generally work with an appraiser to make sure the home wasn’t overpriced or damaged in unseen ways. A closing attorney would manage the end of the transaction to make sure there are no misunderstood documents or sudden surprises. Those checks and balances often don’t exist in mobile-home transactions, so you end up with vulnerable buyers facing a high-pressure sales environment in which the manufacturer, retailer, lender and insurance broker may all be part of the same company."
    "(...)That said, in some other aspects, you have to describe an array of anecdotes. There’s no data in the world that says “X% of all Clayton borrowers were promised refinancing.” But we heard that story repeatedly from consumers. There’s no data that says precisely how many Clayton borrowers were told to cut back on grocery and medical payments,” but we
    heard borrowers say that repeatedly. In some cases it was eerie to hear a borrower to voluntarily describe their experiences and have it be nearly identical to stories we’d heard from other people in other states. --MB”

    Yes there is one sheet of paper saying that customers can choose their lenders.
    But yes at the end many customers (70%) use Clayton finance company since a long time( at least 1992). See old 10K sec filing for Clayton :
    Look for the table : "(...) relative percentages of homes sold by Company-owned retail centers that were financed through the Company, either by VMF or by conventional lenders, and those sales made to customers who arranged their own financing or paid cash."

    Why such a high % (70%) ? Because managers have incentives for selling their own company mortgages.
    see:Clayton Homes’ retail managers are paid a tiny base salary ($19,000 a year), but they get 40% to 50% of the profits of their stores. The manager also gets a cut of the mortgage payments (as much as $30,000 a month) on homes financed at his branch."
    2002 Forbes article :

    Clayton Homes, Inc. is far and away the dominant player. Not only is its market share way more than its two nearest competitors combined, but the company also owns two major banks–Vanderbilt Mortgage and 21st. Century–that specialize in retail MH loans which together account for 35% of all MH home loans. In fact, annual combined profit from the two banks significantly exceeds that from the sale of homes from Clayton and its many subsidiary builders.”

    1. Anonymous further posted:

      More links :
      “Problem #1 is the substantial "bait & switch". You are quoted a 7% interest rate, and then at closing it is 12%. That is simply no good.
      Problem # 2 is the egging consumers on by having them prep a site for the home & then jacking up the rates/price. Of course, the consumers should get the loan FIRST before doing prep work...but these are not exactly sophisticated consumers.”
      Manufactured Home Monthly Shipments (1959 - Current)
      About 19 million people, or 6% of the U.S. population, live in manufactured homes, the MHI says.

  5. First of all, thanks to the anonymous poster for all the links. I plan on reading all of it later.
    But right away, two things come to mind. As for the comparison between purchasing a traditional home and a manufactured home,
    it doesn't really make sense to me. An appraiser is hired to evaluate homes, but that's not for new construction, right?
    Why would a factory built home, to be built brand new, have to be appraised? Yes, you need a used, 3-year old BMW to be
    appraised, but not a brand new one you buy at the dealer. You pay the MSRP, or whatever you negotiate.

    As for the high percentage of Clayton Homes buyers borrowing from Clayton, isn't that because of the buyers' credit?
    If they can get an attractive loan from Wells Fargo, or an FHA loan (which Clayton would like you to get), they would do that.
    But I doubt Clayton home buyers can get such loans. So that doesn't surprise me at all and I don't see it as a problem, really.

    But anyway, I don't know much about the industry. I'll read up all the links and maybe I'll come back to the topic.

    Thanks again for the info.

    1. OK, so I went through all of the links above and I still don't find anything too alarming. The complaints at the consumer affairs websites number under 200 each. Clayton sells 30,000 homes per year, so that's really small. Also, like I said, the BBB complaints 172 in 3 years, even if just one region.

      And then in the reddit section, there was an excerpt from a Forbes article (old article) that shows that Clayton store managers are paid on making loans too, but it conveniently left out an important sentence. Here is what they excerpted:
      Forbes article 2002:

      Clayton wants his employees to think about what happens to the home after the initial sale. "We knew that we had to build solid homes because we would be financing them for 30 years," he says. Clayton Homes' retail managers are paid a tiny base salary ($19,000 a year), but they get 40% to 50% of the profits of their stores. The manager also gets a cut of the mortgage payments (as much as $30,000 a month) on homes financed at his branch.

      And then they left out this next, I think crucial, sentence: A sour loan cuts into the manager's income.

      A SOUR LOAN CUTS INTO THE MANAGER'S INCOME. That's kind of important to point out when someone claims that the manager is motivated to act poorly.

      Anyway, I though there would be more material here to make a post out of it, but so far there isn't enough; maybe I will if I see more things I can respond to over time.

      Also, Buffett admitting that defaults are more than the 3% he claimed at the annual meeting is just a matter of definition. When talking about bad loans, we usually talk about charge-off rates per year, how many percent of loans are past due (at the moment) etc, so it's not an issue at all.

    2. Oops, actually the 172 figure at the BBB might be a national figure. It says Eastern Tennessee, but there was a complaint from NC, so maybe BBB just categorizes by domicile of the company. Vanderbilt Mortgage had 39 closed complaints. I don't know what this stuff means, but these numbers seem awfully small to me. With such nasty practices as described in these articles, wouldn't these numbers be much higher? Wouldn't there be way more lawsuits and other indications of systemic problems?

    3. Thanks kk! It is not the journalists on reddit who did the bad excerpt cut of the forbes article, it is me ! I am sorry. My bad cut was not made intentionally (as I wrote I agree "BRK is right keeping the loans on their book." ! ). Regarding if the practices are widespread, I don't know for sure neither ! As Munger would say, incentives precede the company's culture. Mr. Buffett, the other day, on CNBC detailed the amount of fines given by the regulators to Clayton finance company on different states and it was fairly small.

  6. I thought the questions at the BRK meeting this year were exceptionally terrible - the worst in my 5 years of going. The questions reflected a lot of ignorance of Buffett and Berkshire. However, Warren & Charlie are exceptionally good at giving great (thoughtful and entertaining) answers to bad questions. However, Warren and Charlie adequately dodged the question on Ted & Todd - I really wish Warren or Charlie would give a thoughtful answer to the investment perspective and qualities of Ted and Todd and how their circle of competence are different.

    People who criticize the 3G partnerships seem to forget that BRK has 25 (or so) people at HQ for a company with a market cap of $350B. A big difference in 3G and Warren is that Warren never had to downsize because never up-sized.

    My last brief comment is that I agree with Loeb and I also did not get the vibe that Loeb was firing missiles, just pointing out some inconsistencies. I am a huge Buffett fan, huge, but I agree with D-Loeb and I think he was just trying to help us Buffett-obsessors to step back and face reality a bit about him. However, we all have to live with inconsistency in our lives. We can try to remedy that, but that's one of the great and frustrating things about life.

  7. With regards to Clayton homes, here is a very sad fact. If you give poor people exactly what you want, you end up burying them. Poor people (regardless of what that article said) are on average dumber than the rest of us, significantly so. They are short sighted and not able to compute long term costs and benefits accurately. They want stuff "now" and don't like to save for stuff. It is proven that the kid who can't wait a few minutes for 2 cookies vs. 1 has a worse life than the kid that can wait, etc. I am certain that Clayton Homes gives their market (poor people) just what it wants... and that is exactly why it buries them. The basic issue has likely been true for 1000's of years.

    1. That's true; one thing about poorer people is that they really don't have a good grasp on the concept of money. They think whatever money they don't have, just borrow etc.

      I am still looking for a critical mass of complaints to prove that this is systemic. As I said above, I really don't see a lot of complaints at BBB, even at Vanderbilt Mortgage etc. Sure, BBB may be phony (rigged). I looked at other places, Consumer affairs, ripoff report and others but I just don't see the huge amount of complaints you would expect if what the articles say were standard operating procedure.

      Also, as I said above, someone quoted a Forbes article saying managers are paid partly on loan origination but then didn't say that the managers income is affected by bad loans etc...

      So even if Clayton gives the poor exactly what it wants, it's not in their interest to intentionally originate loans they know will go bad (store managers will be penalized and Clayton would lose money; some article said that even at best, loan recovery would only be 50%).

      But anyway, as Munger said, it's hard to be in this business either way.

  8. One other thing with 3G - It is obvious to most anyone who has worked at a large corporation that most seem to be tremendously overstaffed. The real issue is not the layoffs in and of themselves (as clearly, huge % of most workers are not contributing anything even at supposedly "well run" corporations, from an insiders point of view) but that there is basically nothing else in the economy for these people to do. There is no alternative job. That is the real problem. Many, many people are just hanging on to a decent "middle" class life, and when the are "axed" they start to fall and in all likelihood can't get up again, because the economy does not need them or millions of others. Naturally the agent of change that points this out is resented - its a serious problem.

  9. Do you have a link to those books about Japan you referred to? I'd be interested in reading them.

    1. No, I read them in Japanese, actually. But you can probably find a lot about the subject googling "working poor in Japan".

  10. Really enjoyed your very balanced analysis and I actually agree with most of what you have said about Buffet. Me too have been very bothered about the biased views widely spread in the press, some of them extremely annoying. One sometimes wonders how people could be so blind, illogical, or biased (either intentionally or unintentionally). In fact, why don't you put this one up for publication on any one of WSJ, NYTimes, or whatever else you see fit. The intention is not to invite trouble or controversy for yourself, but simply for the good of the public. The general public on these issues are either extremely uninformed or biased, in my opinion. Anyway, that aside, I have been reading your blog for the past year and have really learned a lot. So here is a big thank you! I really think yours is one of the best, if not already THE best of all blogs on investment. On a different note, I wonder if you have ever looked at Brookfield Asset Management (BAM). Lou Simpson recently built a sizable position. BAM is led by Bruce Flatt. He has a long and very successful record with BAM, returning more than 15% a year for the last 20 years. Would you care about doing a piece on BAM and comment on its business model, future growth prospects, and current valuation level? BAM has a few segments and have had a few equity offerings in the recent past. I find it a bit hard to get my hands around its reported financials and look at its valuation, seemingly much harder to value than a Berkshire, Markel, or a Wells Fargo. Any comments would be highly appreciated.

    1. Hi,
      Thanks for the comment. Yes, BAM is a great company. I've owned it in the past and sort of follow it; not so much now as I used to. But it is a well-run company. I just wasn't all that interested in real estate and infrastructure stuff, but these guys make more than the usual real estate/infrastructure type returns due to their structure; earning fees on outside capital etc.

      This company certainly fits into the profile of companies I write about here and it's sort of been on my to-do list. I might post something about it some day... I will take a closer look soon.

    2. Thanks for the quick brief reply, and also nice to know you did dabble into BAM in the past, although not on your current list of coverage. I'm mostly looking for the proper way of looking at BAM's valuation. For instance, what anchor to use, price to earnings, price to cash flow, price to book value, price to NAV? In fact, due to my limitations with accounting and BAM's consolidated financial statements, I'm not even sure what its true book value is, after deducting what it doesn't own in the controlling interests. Right now, yahoo says it's trading at 1.2 P/B, while data from GuruFocus indicates it's 1.8. That's far apart! So the situation for me is, not only do I not know what anchor to use, but also not knowing the very value of that anchor (if the chosen anchor is book value). I'm in fact leaning towards using P/B or P/NAV, given its nature of business. From its CEO letters from the past, BAM seems at times to have favored cash flow or what they call FFO (funds from operations). Again, look forward to reading whatever you would put out on this one.

    3. Hi, Yahoo looks a little off. It might be that they forgot to adjust for the 3/2 split that just happened; that would explain the divergence perfectly.

      As for valuing BAM, I would start with BPS plus whatever the asset management business is worth. Most of their assets are held through the listed entities which are consolidated on BAM's books. Interestingly, they mark those assets (the underlying assets, not the listed stocks) to fair value quarterly. They used to report in the quarterly reports what they thought the assets were worth which was convenient, but now they are actually marking their assets to fair value. That's not a problem because the assumptions are listed in the reports; discount rate, cap rates, terminal value etc... So you can look at that to see if it's reasonable or not.

      So you have balance sheet value right there. And then they get management fees and carried interest on what their clients own. BAM values that business at $10 billion or so, so that adds another $15/share, I think. So fair value is $35/share or something like that (I am being really rough here...).

      But their GP valuation (value of asset management) uses a 20x multiple on fee related earnings and a 10x multiple on carried interest. That may be high or low depending on what you think of these businesses. Listed private equity firms seem to trade these days at 10x earnings, so the above might be a little high. But you can make adjustements yourself.

      This information is in their presentations at the investor relations website. Balance sheet stuff, of course, is in their annual report. I know there is 1Q2015 info out already, but I just did the above with the 2014 annual report.

      Either way, BAM is a great company.

    4. So it appears similar to Berkshire, this is again a 2-column valuation exercise: the investment business + the fee bearing business. I'm quite green in this type of analysis. But after your simple explanation, going back to read their presentation now made a lot more sense. If their fee bearing business indeed grows as they are projecting in the slides, say, 15+% per year for the next 5 years, 20x multiple could be sensible. The question is how much margin of safety there is in paying that type of multiple. What I like about BAM is four folded: 1. they deal with real assets, so there is an inherent hedge against inflation; 2. they have built a worldwide platform with large scale for capital allocation and sourcing investments; 3. The CEO Bruce Flatt and its partners collectively own a very significant portion of the company, more than 20%, I believe. 4. These guys are savvy and disciplined value investors. The large platform allows them to deploy capital as the opportunities arise.

    5. Yes, there is much to like here. But be careful about the inflation part. It's true 'real' assets are good inflation hedges, but at the same time, a lot of the gains BAM has been booking come from lower interest rates leading to lower discount rates and higher valuations. If we get a lot of inflation, discount rates, cap rates and terminal cap rates may start moving back up.

      I remember they had a slide not too long ago showing their cap rates versus interest rates, and the cap rates have not come down as much as interest rates so there is somewhat of a cushion. But I would not assume that they won't go back up at least some...

      Oh, and there was an investigative report on BAM a couple of years ago... I just reread it and I don't see anything that I would worry about except a small real estate transaction, but it's so small it's hardly material. That doesn't mean it's OK, of course. But I don't think it's indicative or a warning about BAM in any way...

    6. Thanks for the downside cautioning. Yes, if inflation sets in and interest rates move up, not only do BAM's assets get re-marked down due to higher discounting, but also I believe the whole equity market will get re-rated down. In spite of the fact that the Shiller PE is 50-60% higher than its historical average, I think the main reason why most people (including Buffet) are not calling this market outrageously over valued is because of the extremely low interest rates, which make future earnings stream worth much more to the present and hence higher market multiple. So in my mind, the worry about BAM's asset getting re-marked down with rising rates is not so different from the worry about the same valuation impact on the entire equity market. Not that that makes me worry less, not at all. Can you link in the investigative report on BAM? Would be very interested in reading it.

    7. Hi, here it is:

      I looked at it and don't think there is much there. I don't think the author understands the nature of the business all that much.

      Also, as for interest rates, the stock market and BAM, you are right, but I looked at the relationship between the stock market and interest rates in the post after this one and there is quite a cushion (even though short term market impact from taper tantrum like shocks will happen).

      But I'm not sure what the cushion is for hard assets.

      Also, a lot of the funds flowing into BAM's funds, I think, are a lot more fixed income alternatives than the capital flowing into stocks; infrastructure and real estate funds are closer to fixed income. So if rates rise and capital flows back to bonds, it may very well flow out of these funds more than from the stock market.

      But I don't really know. It's just something to think about. BAM seems to be very well managed so that may not be an issue longer term.

    8. Thanks for the link. Good point on thinking about fund flows and different type of investors and investment vehicles. All appreciated.

    9. This dovetails well with Cable Cowboy/John Malone. I think SIRF (or other critics of BAM's structure and accounting emphasis) would go even more bonkers with TCI/Liberty maneuvers, emphasis on cash-flow, and voting stocks. Plus Malone does a bunch of questionable insider deals. I wouldn't want to minimize any concerns investors might have, but part of it is management enriching themselves disproportionately and can management be trusted. I think there's usually an issue with management, but Greenblatt in Stock Market Genius stated many times that he actually likes it when management if given options to better align interest.

      I'm interested in your take on BAM too (whenever you feel to getting around to it). I had some from a long time for a mysterious reason (I think cause I like that BAM was into renewable energy back when I cared about social investing). BAM seems like a good case study for a lot of the different things you usually look into: Outsider-ish capital allocator, spinning off various parts of business (kind of), good long term track record, kinda straightforward businesses (most of which has long term contracts) and they seem to constantly transforming themselves into a more ideal version of whatever it is they want to be.

      Maybe I've fallen into the cult of personality but I really admire the execution and ability of Bruce Flatt. A big part of my continual investing in BAM is due to him. Is 12-15% long term total return ambitious or modest for BAM? I also remember during one of BAM's investor day, a shareholder complained about the dividend, and not long after BAM resumed increases in dividends.

    10. I like BAM and think it's great. 12-15% long term is probably doable, but it will get harder as they get bigger, as usual with anything like this. The only reason why I don't own it is that I have never been a big fan of commercial real estate. By the way, what they did to the World Financial Center in downtown NYC is amazing. I haven't seen it recently, but was there when the food court opened and it is really great. I am not surprised they filled Merrill's space right away.

      What I missed, I guess, is the additional boost they are getting from asset management (fee/carried interest) which I knew about, but guess I underestimated, plus they keep turning over the portfolio; get out of mature, stable assets and get into higher return assets.

      Again, the only reason I don't own it has nothing to do with Flatt or BAM, but just that I wasn't that interested in commercial real estate, infrastructure etc...

      But BAM has shown that BAM itself can earn returns higher than what would be expected in a typical commercial real estate or infrastructure business.

      Maybe I need to make a post about BAM...

    11. I can see commercial real estate being a concern, vacancy and cyclicality seems like constant issues, especially as potential tenants are undergoing great industry transition (banking). Though BAM are good with execution and pricing. BAM stated many times that they do manage their vacancy quite well, and most of their rent have upside ... which means there's downside protection?

      Anything about infrastructure that you don't like. Potential return not enough? Too much other risk? From what I gather, it's suppose to be necessary and predictable. I think you said once that as more funds get into infrastructure - and there certainly seems to be that way - things get more dicey.

      If BAM was a significant (or oversized) position for me, I would be more wary of the same things, commercial RE, infrastructure, etc., but as my portfolio is constructed, I'm thinking of BAM as good company with less correlated diversification.

      I also don't feel like management is shady, they seem to be fairly forthcoming. Is their structure really that convoluted? Seems more straightforward especially now that most of the sub companies are public, and for the most part they seem to be trying to make it more and more simple. On the business side, they tell what their plans are and more or less execute on that. I heard Markel feels the same way - as expressed by their BAM position and business relationship.

    12. There's nothing wrong with those asset classes; it was just a personal preference, that's all. BAM has done really well in this area, so I was sort of wrong on that front. I sort of looked at it as owning a bunch of alternative assets, but it's much more than that due to the leverage they get from asset management and higher than underlying asset returns due to turning the portfolio over. Those are the things I underestimated about BAM.

      So don't worry; it's just my own "I'd rather buy MKL that buys stocks and operating businesses than BAM that buys commercial buildings, power plants, bridges and forestry" etc...

      And yes, as far as I'm concerned, I think BAM is a high quality operation.

  11. One more thing about the hedge fund - not only did Buffet not take a management fee, the partnership agreement called for him to absorb all losses, even beyond his capital account!

  12. I think people take Buffett's comments too literally. Remember, a lot of "Moms & Pops" out there listen to his comments.

    Most people would do better by buying & holding "good" companies. That doesn't mean trading, investing in cigar butts, etc isn't a good idea if you're willing to work at it. The chances are slim that an average person would be willing to put in the work though.

    Most people would do better investing in an index fund as opposed to a mutual fund or hedge fund. That doesn't mean some funds aren't worth the money. The chances are slim that the average person picks the right fund though.

    Etc. etc.


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