26-May-2006

>Some Munger Ideas

On the IQ of the 'Smart Money'
Munger does not normally make any comments of his own before the question-and-answer session, but he did this year because, "so many of you [attendees] have come so far." He reminded the crowd that, "if there's any efficiency at all, asset classes converge in the long run," and used that comment as a launching point to talk about the dangers of chasing performance and listening to self-interested experts charging high fees. After noting that alternative asset classes--such as commodities and real estate--have done very well over the past few years, he pointed out that many institutional investors have only recently been allocating more assets to these areas.

Munger drew a parallel between this trend and what happened with venture capital investing several years ago. "Places like Harvard and Yale [endowments] were early into venture capital, so they got access to the best managers. Envy then rippled through the world of investment management, and firms rose up to satisfy the demand. Everyone piled in during the late 1990s, and promptly lost half their money. Something like that will happen again in other areas."

The key point here is that chasing the asset class that's been the most hot most recently rarely works out well for investors. It generally works out very well, however, for the consultants and investment managers selling the "product" that's been created to satisfy investors' demand. As Munger put it at the meeting, "How can anyone be so uncynical about human nature?"

Many managers and investment professionals will create and hawk whatever will sell, regardless of whether it's right for investors. Remember all those Internet funds launched near the top of the Nasdaq? Or all the recent launches of emerging-markets and precious-metals funds? Caveat emptor.

On Asset Prices
Munger: "Every asset class I see is priced on a fairly rich basis.... Junk bonds seem to me to be pretty junky. The easy bargains are picked over because people like you are willing to come so far to hear about value investing. Of course, if a thing is despised enough, you can run a Geiger counter over it and make it go click."

He then related the story of someone he knew who'd started a fund to invest in companies in sub-Saharan Africa, illustrating that even such an out-of-the-way corner of the world was being picked over. Munger also recalled a comment made by Buffett at the Berkshire annual meeting concerning how cheap Korean stocks had become during that country's financial meltdown in 2002: "There were flour mills trading at 2 times earnings. Warren thought he was young again."

The underlying message here is simple to understand, but difficult to carry out: Investing in what's out of favor or overlooked will generally bring a better return than buying whatever happens to be in the headlines. It's a message that's made Munger and Buffett very wealthy, and it's a central theme of Morningstar's investing philosophy.

On Opportunity Costs
Buffett often talks about how much more money Berkshire could have made if he had acted on certain opportunities rather than "thumb sucking," as he has put it. Munger hit on a similar theme a couple of times during the Wesco meeting.

"The proper thing to do is look back and think what huge opportunities we all missed," he said. "We didn't scan enough areas looking for opportunities."

Then later in the meeting: "You can miss a lot. As long as you get some, and don't make monstrous mistakes, you'll do fine. But you should constantly review mistakes of omission." Munger related the story of fund manager Chris Davis' wall of shame--on which he posts the certificates of stocks that represent his worst losses--and mentioned that everyone should have a "wall of shame squared," reviewing all the things "you could have done if you'd been a bit more rational."

I couldn't agree more. As Munger put it simply, "You will be a better investor if you do this."

On Everything Else
As usual, Munger's answers to questions from the audience were rife with great quotes. Here are a few that I managed to scribble down, with context appended where it's necessary.

"There's always a lot of nonsense that's conventional."

On the way the accounting profession has handled accounting for derivatives: "I don't think giving up is the right word. They've sold out."

When asked for some financial detail on Iscar, the Israel-based metalworking company recently purchased by Berkshire: "That's a very intelligent question, so I will give you a very intelligent answer. I'm not going to tell you."

"I don't know how we'll fix corporate compensation. When people rise high in life, they have a duty to act as an example. Look at judges and generals, for example. The culture's horribly awry, and I don't know how to fix it."

"There will be some repeat of LTCM somewhere. You can count on it."

"The harder you work on something, the more confidence you have in it. But you might be working on something you aren't good at."

When asked whether he considers buying businesses outright and managing them more honorable than managing a portfolio of equities: "Hell, yes. It's a more engaged life. Why must people constantly flip just to add an extra zero?"

When asked whether he has an opinion about naked short-selling: "My jihad calendar is full up."

12-May-2006

>7 Lessons from the Racetrack

7 super cool ideas..! enjoy :p

1. "At the racetrack ... every bettor is playing only against the other bettors.... Your opportunity for profit at the racetrack consists entirely of mistakes that your competition makes in assessing each horse's probability in winning."

It's both important and sobering to remember that on the other side of every transaction is another person,who holds an exactly opposite view. Achieving above-average returns (on a risk-adjusted basis) requires seeing value where others currently don't.

2. "This is the way we all have been conditioned to think: Find the winner, then bet. Know your horses, and the money will take care of itself. Stare at the past performances long enough, and the winner will jump off the page.... The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory."

A good company is easy to spot, a good value is not. Many people spend all of their time searching for the next big stock idea, yet wouldn't have a clue about what's already priced into the stock of whatever company they find. Knowing how to value a business is key.

3. "...Handicap[ing] horses is work that you do before the betting opens. As soon as those first prices go up on the board, you are looking for discrepancies between your odds and those set by your opponents....

You must have a clear sense of what price every horse should be, and be prepared to discard your plans and seize new opportunities depending solely on the tote board."

The key is that good investors, like good horseplayers, do their homework ahead of time to become familiar with what they're looking at. Good investors put themselves in the position to act quickly when bargains emerge because, as every shopper knows, a good bargain doesn't last long.

4. "It might not be a great deal of fun, but you could sit around and wait for mismatches, races in which one horse is so clearly superior to the competition that anyone could fairly agree that he has a better than 50 percent chance of winning the race.... There is no shame in passing a race because you just don't
see any value in it."

"Sitting around and waiting for mismatches" is exactly what Warren Buffett has done for the past half-century. He is well aware that "shame" comes not from shrewdly "passing a race," but recklessly entering one. "You don't get paid for activity," Buffett instructed, "You get paid for being right."

5. "What defines sucker money is not the horse selected, but the acceptance of odds on that horse that are substantially out of line with its chances of winning."
A bad (or good) investment has as much to do with what price was paid as it does with what business was bought. So it's entirely possible that the stock of a bad business can offer attractive returns. And just as a bad company can make for a good investment bet, a good company can be a bad investment bet.

6. "...The world's savviest bettor cannot win with bad opinions"

There are plenty of people who come up with very precise valuations for companies (down to the penny in some cases), yet their knowledge of the companies is scant, and therefore, their valuations worthless. Truly understanding the business is a prerequisite for valuation.

7. Finally, as Crist says, "If all of this seems too calculating and joyless, by all means feel free to forget about it and enjoy yourself at the races betting horses you fancy regardless of their price. You'll have plenty of company, and the rest of us could use your money."

09-May-2006

>Buffett solves his cash crisis

If every year you had more cash than the year before, would you have a problem with that? If every year you had a lot more cash than the year before, would you have a problem with that? And if, at last count, your cash had piled up to $37 billion, would you have a problem with that?
You would if you were Warren Buffett -- and this embarrassment of riches has been bothering the chairman of Berkshire Hathaway (Research) Inc. for years.

Buffett: This is a significant event in Berkshire's history.

That's why his announcement this week that he is spending $4 billion in cash to buy Iscar, an Israeli-based machine-tool maker, is so important. "It's the first business we've purchased that's based outside the US," Buffett said on Saturday in his remarks to 24,000 shareholders assembled at Berkshire's annual meeting in Omaha. "I think we'll look back on this in five or ten years and see this as a very significant event in Berkshire's history."
A turning point
The Iscar purchase is a sign that Buffett and his vice chairman, Charles Munger, may be finding a way out of Berkshire's unique kind of cash crisis. Most companies struggle to produce excess cash after paying all their costs. Buffett's investments are so lucrative that he struggles to find ways to put all their excess cash to work.
Those billions in cash are a problem for Buffett because:
• Interest rates are low, so idle money earns meager returns.
• He believes the value of the US dollar will decline for years to come, making cash a wasting asset that may be worth less with each passing year.
• At Berkshire's current market capitalization of roughly $130 billion, it's hard for Buffett to find publicly traded stocks both cheap enough and big enough to make a difference in his company's overall results.
• The hundreds of billions of dollars pouring into hedge funds and private equity funds have made it difficult to buy private businesses in the US at fair prices.
All these factors combine to make Buffett's original game – buying small, publicly traded US companies – next to impossible. And they make it almost as hard to buy bigger US stocks, too. At Saturday's annual meeting, Buffett revealed that Berkshire – which as of March had $37 billion in cash – is looking at one acquisition for about $15 billion in cash. (He, Bill Gates, and the royal family of Saudi Arabia may be the only people alive who could consider such a thing.) But he warned sternly that this particular deal has a "low probability" of occurring.
"We don't like excess cash," said Buffett, "but we like dumb deals even less. It's likely, but far from certain, that three years from now we will have significantly less cash." And how much less is "significantly" less? "We don't need anything remotely like $40 billion [in cash]," explained Buffett. "We would be much happier if we had $10 billion." (Hey, who wouldn't?)
No dividend
So how will Buffett get rid of all that extra cash? To me, the most interesting thing about his remarks at this year's meeting was the word he never uttered: dividend. In years past, Buffett has admitted that if he could not find a better use for the mountain of cash that his shareholders have entrusted him with, then he would have to consider paying out a special dividend, much as Microsoft (Research) did in 2004. This year he never spoke the D-word, which suggests to me that the Iscar deal may be a template for a new solution to his cash problem. Iscar has several advantages:
• Based in Israel and operating mainly outside the US, it generates most of its cash in foreign currency.
• It was a private transaction, so Buffett did not have to outbid competitors in a public auction.
• It was a sizable deal, enabling him to put a good chunk of cash to work at once.
• And, most importantly, it will send a signal to major family-owned businesses around the world that Buffett is now a buyer of choice beyond the borders of the US.
By turning the Wertheimer family, the main owners of Iscar, into instant billionaires, Buffett has sent out a wake-up call to similar potential partners everywhere.
It's important to realize what's going on inside Buffett and Munger's heads. They view capital allocation – how the cash should be redirected among the dozens of different businesses that make up Berkshire Hathaway – as their single most important responsibility. They also think they can add at least as much value with smart capital allocation as they can with smart stock picking. After all, inside a conglomerate like Berkshire, even a business with only marginal profits can be valuable if Buffett and Munger can redirect its excess cash to a faster-growing division that has a better use for the capital.
With each passing year, they seem to become a little less interested in buying small stakes of companies that trade in the stock market – and more interested in buying majority holdings in private businesses. That, they believe, is how they can now get the biggest bang for their big bucks.
Buffett and Munger are more thoughtful about what to do with cash than any other business leaders in America. That's because they know that cash is like most good things in life: It takes only a tiny bit too much to turn it from a blessing into a curse.
As Buffett's mentor, Benjamin Graham, explained in Chapter 19 of his book The Intelligent Investor, the better a boss is at managing the operations of his business, the worse he is likely to be at managing its finances. That's because a well-managed business mints money – and those piles of cash lead to temptation.
Most corporate managers could find 37 billion ways to spend $37 billion – nearly all of them bad. They might go on an acquisition binge, paying any cost and bearing any burden to buy any company they came across. They might build a 60-story skyscraper with their name on it, expand their product lines into markets they knew nothing about, or spend a fortune on research and development for goods that nobody wanted.
Even more likely, they would pay themselves hundreds of millions of dollars in stock options, then spend even more money to buy back the company's shares on the open market. They would call this "enhancing shareholder value," since it would supposedly keep the new stock options from "diluting" the stake of existing shareholders.
For several years Buffett seems to have been casting about, trying to find a way to solve his peculiar cash crisis without having to admit defeat and pay out a big (and taxable) dividend. The Iscar deal is a strong hint that he may have largely solved this problem. Of the $25 billion to $30 billion that Buffett hopes to invest over the next few years, it wouldn't surprise me a bit if the lion's share of it went into private companies based outside the U.S.

>India and China

China is in a tearing hurry to tap the Indian market and the CCPIT’s assistant chairman Wang Jinzhen lost no time in putting his cards on the table. China would like India to accord it market economy status as quickly as possible. It would like clarity on foreign direct investment in the retail sector, and it would be helpful if India’s infrastructure sector could be opened up to Chinese companies without further ado. Additionally, it would also like the controversy surrounding its telecom giant Huawei Technologies resolved quickly, so that new investment in India could be speeded up, as the record on investments has been fairly dismal so far (see ‘Needles of Suspicion’).

But whatever the misgivings on either side, trade is booming —even if there is no agreement on who is gaining. According to the latest statistics released by China Customs, two-way trade grew 79 per cent to touch $13.5 billion in 2004, and reached $18.7 billion in 2005. This means the target, set three years ago, of reaching $20 billion by 2008 could be met two years before schedule. It also means that China will soon be overtaking the US as India’s main trading partner.

Why does Indian industry blanch at the idea of an FTA with China? The answer lies in the structure of their economies and their relative strengths. Slightly over 50 per cent of China’s GDP comes from manufacturing and construction, 34.5 per cent from services and just under 15 per cent from agriculture. The fear is that the world’s factory will be flooding India with its products.

Compare this with India’s profile. More than half of its GDP (52.2 per cent) comes from services, while industry contributes just 26 per cent. As one businessman points out, “What will we gain from an FTA with China? Not lower tariffs because their tariffs are already low. All it will do is open the floodgates. Just look at what it has done to the big economies. Both the US and Japan have a huge trade deficit with China and we are pygmies compared to them.”

Ready or not, Indian industry will have to learn to tango with the dragon. China is here and it means business.

05-May-2006

>Information Vs Knowledge

  • Until the lens of experience focuses information, it does almost no good.
  • No matter how much the marketing machines of the Information Age would have us think otherwise, information by itself isn't power: knowledge is.
  • And turning information into knowledge requires more time, experience, and effort than an afternoon spent starting at a screen full of facts.
  • Information is passive. To make it knowledge, you need to assimilate it. Put it in context. Understand it.
  • Knowledge streamlines and focuses our relationship with information.
  • Knowledge helps us avoid information we don't want or need and leaves us with the stuff we can use.
  • In an age in which endless amounts of bits and bytes are always available, it's a daunting task to spot the worthwhile stuff.
  • It's easy for the Net to overwhelm us or lull us into the misconception that simply having access to something is as good as knowing it. --Michael Penwarden