giofranchi

shalab, I am not sure I understood your question correctly: with investments/share you mean the value of the Portfolio investments divided by the number of shares outstanding? If so, why should it have changed? As far as I know, investments/share could increase in four ways: 1) Increasing shareholders’ equity 2) Increasing insurance contract liabilities (increasing float) 3) Increasing debt (or issuing more preferred stocks) 4) Reducing the number of shares outstanding None of them has changed much during the first nine months of 2012. Actually, a Cash Flow Statement could be derived by the changes that occurred in the Balance Sheet from December 31, 2011 until September 30, 2012. And see exactly how investments increased by $263 million. But I guess that is not what you are asking… right? giofranchi

Well, if it really is so, then I don’t like it. When I invest, I want to know exactly whom I am partnering with. If Mr. Buffett is no longer essential to BRK, then I like BRK much less than I used to. I just don’t believe in sustainable outperformance, without an outstanding manager who achieves it. Look, for instance, at JNJ: it is probably the large cap company with the best historical track record in the world, and yet it is clearly underperforming (I am talking about revenue and earnings growth, not share price). Compare it, if you want, with NVS, whose Chairman Mr. Vasella is one of the most accomplished individuals in the pharma industry today. JNJ is trailing NVS both on a revue growth and on an earnings per share growth basis, both on a 5 year and on a 10 year basis. My problem with BRK is only one: to make a $200 billion company grow at a very good rate, an outstanding underwriter is not enough, an outstanding stock picker is not enough, an outstanding businessman is not enough: you need all three. Mr. Buffett is that extraordinary individual, no doubt about that. But he is 82. I know that you all disagree with me, but I prefer FFH, which is an $8 billion company, is led by Mr. Watsa, who is 20 years younger than Mr. Buffett, and is selling at book value. giofranchi Giofranchi, you have nearly persuaded me to reconsider my allocation to FFH. Let me recap the history of about 80% of our portfolio for the last six years. This great majority has been in shifting proportions of LRE, FFH, and BRK. The proportion of LRE has been rising with their price and reinvested dividends while the combined value of FFH and BRK has also risen nicely, especially as we have shifted the allocation between them opportunistically. Most of the time, that allocation has favored FFH. However, for the last 15 months, almost all has been in BRK for reasons that have been discussed. Thanks to your comments, the time may be drawing nigh to reconsider our allocation to FFH. Thank you very much. Well, SharperDingaan has just pointed out something interesting: Most would look for next weeks East Coast weather to generate some very big claims, & a forcing of FFH's P/BV done further because of the re-insurance exposure. If so, I think it could be the right opportunity to start (or to add to) a FFH investment. We will see! giofranchi

Frank, No! It was not me! ;) I try to have no feelings about businesses… ;D No, really: I don’t care how FFH will perform next year or in 2014. All I care about is what they are doing. And I don’t like exposure to market risk, when general stock prices are high and debts are still dangerously unmanaged all over the developed world. Much better to be patient and to concentrate on underwriting profitably. It is just as simple as that. That's why I like what they are doing. Of course, I also don’t jump in and out of stocks. I am sure you are much better than me at doing that, and so you will time the re-entry point in FFH quite satisfactorily! Good for you! :) giofranchi Anyway Frank, I think it might be worth repeating Mr. Watsa’s answer to Mr. Shezad, because it is a great answer, and because it should give some food for thought to all who think they will have a chance in the future to jump on board at a price well below book vale, just because FFH has traded at a discount to book value in the past... Mr. Watsa: “Yes, that was -- Shezad, that's a good question. And so the first thing, just to say you is we've always focused on the long-term and when we went through our 7 lean years, Shezad, we were turning around our company. We were turning around Crum & Forster and the -- take reinsurance and all of that, and that took sometime to turn it around. Today, our companies are in excellent position, they're underwriting-focused, they are well reserved, they've cut back in the soft markets and they are well- positioned to expand significantly at the right time. And then as we are expanding today, you're seeing that in Zenith, and you're seeing it in Crum & Forster, you're seeing it on Odyssey. And the Canadian market's always lag -- have lagged in the past and you'll see it in time in Canada. So underwriting operations are very well-positioned, and our investment philosophy and position -- they're always long term. So when we had credit default swaps in the past, it took a few years for it to work out and as you know, we made a lot of money. And so right now, it's very important not to reach for yield because if you do reach for yield, if you put money into the stock market at these prices, you could suffer permanent losses. We'll take temporary losses but we don't like taking permanent losses. So I don't think we'll be at a position where our results will be poor for a long period of time but you're right for the last year and a half, it hasn't been good. But our results for year ending 2011, for the 5 years, is among the best in the business and of course, for the 26 years ending 2011, it's better than anyone else in our industry. So we're focused on the long-term and we continue, we've always been focused on the long-term, and continue to be focused on doing well for our shareholders always.” giofranchi

Well, if it really is so, then I don’t like it. When I invest, I want to know exactly whom I am partnering with. If Mr. Buffett is no longer essential to BRK, then I like BRK much less than I used to. I just don’t believe in sustainable outperformance, without an outstanding manager who achieves it. Look, for instance, at JNJ: it is probably the large cap company with the best historical track record in the world, and yet it is clearly underperforming (I am talking about revenue and earnings growth, not share price). Compare it, if you want, with NVS, whose Chairman Mr. Vasella is one of the most accomplished individuals in the pharma industry today. JNJ is trailing NVS both on a revue growth and on an earnings per share growth basis, both on a 5 year and on a 10 year basis. My problem with BRK is only one: to make a $200 billion company grow at a very good rate, an outstanding underwriter is not enough, an outstanding stock picker is not enough, an outstanding businessman is not enough: you need all three. Mr. Buffett is that extraordinary individual, no doubt about that. But he is 82. I know that you all disagree with me, but I prefer FFH, which is an $8 billion company, is led by Mr. Watsa, who is 20 years younger than Mr. Buffett, and is selling at book value. giofranchi

berkshiremystery, I sincerely hope all the best to your friend and I applaud your willingness to give him support, in his time of need. You are a caring person. God bless you, giofranchi

Hi Uccmal, I have just checked and found out Mr. Watsa bought 26,848,500 shares of RIM, from 2010Q3 to 2012Q2, at an average price of $26.07. So, FFH invested $700 million in RIM: just in between your figure and mine! By the end of 2011Q4, though, FFH already owned 12,798,300 RIM shares, and they were trading around $19. So, by the end of 2011Q4, FFH’s investment in RIM was worth $243,167,700. Later, in 2012Q1, Mr. Watsa bought another 14,050,200 shares at an average price of $15.05, a total investment of $211,455,510. As of yesterday, FFH’s investment in RIM was worth: $7.57 x 26,848,500 = $203,243,145. In 2012 FFH has lost, only in the RIM investment: ($243,167,700 + $211,455,510) - $203,243,145 = $251,380,065. If you just add back those millions to the $523.7 million of equity gains, you get to an annual return of more than 20% for all the other equity holdings of FFH, Dell included! :) Please, let me know, if you have different numbers! I clearly know nothing about 2013 or even about 2014, but if I could hold just one investment for my son with a 10 years horizon, that investment would be FFH. ;) giofranchi

Who knows, right? I guess both are true: Net Premiums Written increased 5.6% for the third quarter and 9.5% for the first nine months of 2012. So, maybe the market is actually hardening: Mr. Watsa has always said they wouldn’t increase revenue, unless rates improved materially. But I tend also to give due credit to Mr. Barnard’s excellent work: he proved himself many a time while at the helm of OdysseyRe, and now, as supervisor of all insurance operations, I think he is doing well and will continue to perform quite satisfactorily in the future. One more thing: it is easy to dismiss investment returns in a quarter when they were negative… but, please, look at Equity and equity-related investments for the first nine months of 2012: FFH gained $317.1 million in Realized gains and $206.6 million in Unrealized gains, for a total gain of $523.7 million out of a portfolio worth more or less $5 billion. That is a 14% annual rate of return in a year when FFH has lost almost 2/3 of its $900 million investment in RIM. I don’t know how you read those numbers, but to me it seems that Mr. Watsa and his team are going on working their magic on the investment side of the business as well. giofranchi

Frank, I understood you were teasing me… I didn’t make the same mistake I made replying to valuecfa!! ;D Maybe, my answer was too serious nonetheless… I just wasn’t in the vein of joking… sorry! :( giofranchi

+1 giofranchi

I don’t agree. “We continue to maintain our equity hedges and have cash of approximately 33% ($8.1 billion) in our investment portfolios as we are not being adequately paid to take risks with markets at current levels.” In the meantime, the combined ratio has fallen to 95.4%. While not being adequately paid to take risks with markets at current levels, my own firm is focusing on improving its operations. Staying very defensive with its investments and hoarding up cash. The same is true with FFH, and obviously I like this policy. I don’t judge a quarter by the amount of earnings declared, but by the strategy put in place. giofranchi As Tom mentioned, it was a bit of sarcasm on my part Oh… How stupid!!! I completely misunderstood! The fact is, if you compare Q3 2012 with Q3 2011, net earnings of $34.6 million compared to net earnings of $973.9 million, the quarter just ended might actually be labeled “terrible”… Anyway, I should have understood the sarcasm… It is just not a fine day for me… Too many people who don’t do what I ask them to do… or do it superficially… I pay them to solve problems, not to give me problems, right?... Sorry, my mind right now is somewhere else… giofranchi You might profit by reading a book, The Toyota Way, that describes the way Toyota became transformed into a problem unearthing and problem solving organization. I'm wired this way, but most people are not. One of their principles: genchi genbutsu, emphasizes getting up out of one's desk and going to see for yourself what's wrong at the source. That's often the first step to begin the problem solving process. :) Ok, done. I have just bought it! Thank you very much! :) giofranchi

Frank, No! It was not me! ;) I try to have no feelings about businesses… ;D No, really: I don’t care how FFH will perform next year or in 2014. All I care about is what they are doing. And I don’t like exposure to market risk, when general stock prices are high and debts are still dangerously unmanaged all over the developed world. Much better to be patient and to concentrate on underwriting profitably. It is just as simple as that. That's why I like what they are doing. Of course, I also don’t jump in and out of stocks. I am sure you are much better than me at doing that, and so you will time the re-entry point in FFH quite satisfactorily! Good for you! :) giofranchi

I guess Investments in associates are not quoted on any Exchange (I am not sure and I might be wrong), so I don’t really know how their book value is calculated. But I think fair value should give the idea of how much FFH thinks those investments are actually worth. But, please, look at Common stocks: at book (marked to market) they are worth less than cost. Actually, I believe Mr. Watsa thinks they are worth much more than cost! So, which numbers should we use to calculate “fair book value per share”? All in all, I think it is just better to stick to book value per share, while also being aware of the fact that some investments have the potential to increase it substantially in the future. giofranchi

I don’t agree. “We continue to maintain our equity hedges and have cash of approximately 33% ($8.1 billion) in our investment portfolios as we are not being adequately paid to take risks with markets at current levels.” In the meantime, the combined ratio has fallen to 95.4%. While not being adequately paid to take risks with markets at current levels, my own firm is focusing on improving its operations. Staying very defensive with its investments and hoarding up cash. The same is true with FFH, and obviously I like this policy. I don’t judge a quarter by the amount of earnings declared, but by the strategy put in place. giofranchi As Tom mentioned, it was a bit of sarcasm on my part Oh… How stupid!!! I completely misunderstood! The fact is, if you compare Q3 2012 with Q3 2011, net earnings of $34.6 million compared to net earnings of $973.9 million, the quarter just ended might actually be labeled “terrible”… Anyway, I should have understood the sarcasm… It is just not a fine day for me… Too many people who don’t do what I ask them to do… or do it superficially… I pay them to solve problems, not to give me problems, right?... Sorry, my mind right now is somewhere else… giofranchi

I don’t agree. “We continue to maintain our equity hedges and have cash of approximately 33% ($8.1 billion) in our investment portfolios as we are not being adequately paid to take risks with markets at current levels.” In the meantime, the combined ratio has fallen to 95.4%. While not being adequately paid to take risks with markets at current levels, my own firm is focusing on improving its operations. Staying very defensive with its investments and hoarding up cash. The same is true with FFH, and obviously I like this policy. I don’t judge a quarter by the amount of earnings declared, but by the strategy put in place. giofranchi I'm confused. Is this some kind of devious "double sarcasm" post by Giofranchi? :O tombgrt, my judgment is very simple: I like that they are trying to preserve capital on the investment side of the business, while striving to improve underwriting performance. I think it is the right strategy to employ. And I like it because, even though I am fully aware of the fact that in future quarters earnings will continue to suffer, I think it fits perfectly well with the motto “short term pain for long term gain”. Of course, I might be mistaken! giofranchi

I don’t agree. “We continue to maintain our equity hedges and have cash of approximately 33% ($8.1 billion) in our investment portfolios as we are not being adequately paid to take risks with markets at current levels.” In the meantime, the combined ratio has fallen to 95.4%. While not being adequately paid to take risks with markets at current levels, my own firm is focusing on improving its operations. Staying very defensive with its investments and hoarding up cash. The same is true with FFH, and obviously I like this policy. I don’t judge a quarter by the amount of earnings declared, but by the strategy put in place. giofranchi

Enjoy! giofranchi

Wonderful letter! Thank you very much, giofranchi

Always a good read. giofranchi Q3_2012_Commentary.pdf

I admit I have not read yet the collateral agreement of the loan that BH contracted with Fifth Third Bank. So, mea culpa! Anyway, I don’t understand where the problem is. As long as restaurant operations stay cash flow positive, how Mr. Biglari decides to use the funds he borrowed shouldn’t matter: Cracker Barrel stock price shouldn’t matter. During the 40 weeks ended July 4, 2012, net revenue from restaurant operations was $561,127,000. Total costs and expenses were $531,098,000. Interest on obligations under leases was $7,748,000 and interest expense was $6,200,000. Principal payment on long term debt was $8,379,000 and principal payment on direct financing lease obligations was $4,356,000. So, after paying all BH debt obligations, restaurant operations were still $3,346,000 cash flow positive. I will read the collateral agreement, but I doubt Mr. Biglari is so naïve to be margin called, if he knows he can cover all BH debt obligations solely through the cash provided by restaurant operations. giofranchi

Let’s make a comparison: KFC + TACO BELL + PIZZA HUT vs. STEAK N SHAKE + WESTERN SIZZLIN + CRACKER BARREL. First of all, I like the franchising of fast-food brands business very much: YUM returned 445% since 2001. YUM operates on a global scale and increased EPS 13%-17% each year since 2001. BH won’t be able to achieve such outstanding results. But I like the business anyway. Second: at the end of 2011 YUM had Total Debt of $3.317 billion, Cash of $1.198 billion, and Total Shareholders Equity of $1.823 billion. Net Debt / Total Shareholders Equity = 116%. On July 4, 2012, BH had Total Debt of $104.179 million, Cash of $46.471 million, and Total Shareholders Equity of $332.186 million. Net Debt / Total Shareholders Equity = 17.37%. Also, total debt of BH is decreasing: from $112.558 million on September 28, 2011, to $104.179 on July 4, 2012. Third: of course, we must dig a little bit deeper, to understand if what Mr. Biglari is doing might be judged a sensible thing to do, or if it must be judged a foolish thing to do. During the 40 weeks ended July 4, 2012, BH generated $34.656 million in Cash from operating activities. If we subtract $4.516 million of Capital Expenditures, we get to $30.14 million. Mr. Biglari sold $38.108 million of investments, paid $7.013 million in Changes in due to/from broker, and bought $102.8 million of investment (the entirety of which probably in Cracker Barrel). So, BH generated $30.14 million in free cash, while Mr. Biglari increased investments by $71.705 million: he invested $71.705 - $30.14 = $41.565 million more than BH generated in free cash. But Cash and cash equivalents at the beginning of the 40 weeks period were $98.987 million. So, subtracting other minor changes in Cash (more or less $11 million), BH ended the 40 weeks period with $46.471 million in Cash. So, the question is: is it too little cash? Can this level of Cash be somehow detrimental to Steak n Shake and Western Sizzlin operations? In fact, I myself, before investing, always want to maintain enough Cash to be sure the businesses I control and manage personally will never run into trouble. Once again, let’s make the comparison with YUM: in 2011, YUM had Restaurant Expenses + General & Admistrative Expenses of $10.512 billion with Cash of $1.198 billion. It means that YUM kept enough Cash to cover more or less 1.37 months of cost of operations. Now, during the 40 weeks period BH had Restaurant Expenses + General & Admistrative Expenses of $306.214 million, which, on a 52 weeks basis, become $398.078 million. It means that BH is keeping enough Cash to cover more or less 1.4 months of cost of operations. It looks sensible to me, not reckless. Just a further comparison with MCD: at the end of 2011 Net Debt / Total Shareholders Equity was 70.6%, and it was keeping enough Cash to cover more or less 1.6 months of cost of operations. Fourth: so BH is not “leveraged”, it is just very much “concentrated”. BH right now has just three productive assets: Steak n Shake, Western Sizzlin, and (17% of) Cracker Barrel. Also YUM has just three productive assets, right? I have heard many things about YUM, but never that it is not diversified enough! Many of the businesses we invest in have just one or two significant productive assets (Apple’s iPhone + iPad = 72% of revenue in Q3 2012, and personally I feel I can predict the future of the fast-food industry much better than the future of the iPhone or the iPad!). Fifth: nobody can compel Mr. Biglari to sell shares of Cracker Barrel. On July 4, 2012, BH had $246 million in Investments (the majority of which is Cracker Barrel), and it had $141 million in Paid-in capital + $249 million in Retained earnings + $69 million (at cost) in BH shares held by the consolidated affiliated partnerships. Permanent capital is far greater than Investments and BH can cover interest expenses while staying very well profitable. If you don’t like what BH is becoming, you can sell your shares, and the share price will decline, but you cannot force Mr. Biglari into selling Cracker Barrel shares. To sum up: if you tell me that Mr. Biglari is a crook and cannot be trusted, well then you give me food for thought. If you tell me that BH is a bad business, well then I just don’t agree. giofranchi

Cowboy Ethics: I enjoyed it! http://www.viewfromtheblueridge.com/2012/10/19/cowboy-ethics/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+viewfromtheblueridge%2FJkgK+%28The+View+from+the+Blue+Ridge%29 giofranchi

I have found the letter in attachment to be interesting. giofranchi Broyhill-Letter-Oct-12.pdf

I have received the suggestion to start a thread in which to post “macro” papers worth reading. Of course, they may not be very useful for investing, but they are great fun! ;D I attach the Hoisington Quarterly Review Third Quarter 2012. giofranchi HIM2012Q3.pdf

Good idea! I will surely follow your advice! giofranchi

Well, maybe you are right… Generally, though, I genuinely admire Mr. Charles Gave as a man of great financial learning. I think his ideas are always very well researched and expressed. Of course, you could disagree with his conclusions… but I find it difficult not to enjoy his all-encompassing knowledge. giofranchi