mpauls

What exactly are you looking for?

I'm sure this will interest at least a few people. I think its a good exercise though it's not related to anything specifically important, but if you don't think about this sort of thing it may provide a catalyst to get you started. Let's see who will get it first: If we have 6 players competing in a round robin game of dice. Each player will play a total of 5 games, that is, one game between each player. (To organize this conceptually it may be useful to think about this as five rounds of three games between two teams.) The top 3 players get a prize (assume its an equal prize). (i) We have a three sided die, equally weighted, and marked: ‘A,’B,’C (ii) There is only one roll per game and it makes no difference who rolls the die (iii) ‘A is the most favorable outcome, ‘B the worst. ‘C gives both players the same result. Payoffs : If the roller throws ‘A he gets 3 points and his opponent gets 0 points, if the roller throws ‘C he gets 0 points and his opponent gets 3 points, if the roller throws ‘B both players get 1 point. We don’t care about the the order of the combinations. After the 15 total games are played (5 total games per player) there are a total of 21 different possible combinations of ‘A, ‘B, ‘C, (without respect to the order in which the combinations occurred) however in terms of the payoffs there are only 15 different combinations (b/c some of the different combinations give the same numerical ‘payoff’ result.) Here is some info to help get you started: Total possible results and their payoffs are in a list below. Also consider for example, if one player tallies 5 ‘A rolls then no other player can tally 5 ‘A rolls, rather each other player must have at least 1 ‘C. So there is a bit of conditional probability going on here so think Bayesian. The question is to figure out which three winning combinations occur together and the probability of these results occurring. Results Payoffs (‘A,‘B,‘C) (5,0,0) 15 (4,0,1) 12 (3,0,2) 9 (2,0,3) 6 (1,0,4) 3 (0,0,5) 0 (4,1,0) 13 (3,1,1) 10 (2,1,2) 7 (1,1,3) 4 (0,1,4) 1 (3,2,0) 11 (2,2,1) 8 (1,2,2) 5 (0,2,3) 2 (2,3,0) 9 (1,3,1) 6 (0,3,2) 3 (1,4,0) 7 (0,4,1) 4 (0,5,0) 5

I attached a document that is a running work in progress. It's mostly just some thoughts I put down for my own use but thought it was relevant to this conversation and thought I'd share. Not to worry its nothing too insightful.

I'm yet to read anything that comes even close to getting Buffett's methods correct. But why would anyone actually detail this publicly. (And no Buffett doesn't openly discusses his methods. He may give hints, but he's not spoon feeding.)

I'm aware of greenblatt. Sure Quantitative screens can work, you'll do a few points better than the market, but not substantially so. Sorry, but I don't talk openly about the details of my approach, but you can guess the derivation thereof.

I'm sure I'll get some resistance from this. There is no magic formula. Each situation is different. Each company is ultimately valued differently.

Some of you may wish to begin reading on page 14 of the document (which is page 13 in the pdf reader) http://investor.shareholder.com/common/download/download.cfm?companyid=ONE&fileid=283417&filekey=92060ed3-3393-43a5-a3c1-178390c6eac5&filename=2008_AR_Letter_to_shareholders.pdf

Notes from Berkshire Hathaway’s Annual Meeting, 2009 Link: http://www.gurufocus.com/news.php?id=54571 Notes from Berkshire Hathaway’s Annual Meeting, 2009 Berkshire Hathaway Specifically Berkshire’s property Casualty insurance and utilities businesses are probably the best in the world. Insurance business was growing especially for GEICO. Last year GEICO spent about $800 million on advertising. Advertising money at GEICO is well spent. It’s nearly impossible to calculate how much each dollar of advertising comes back in the way of insurance premiums. But Munger specifically said that if they spend $800 million and get more than $800 million in increased insurance businesses, then that’s $800 million pretax that doesn’t show up on the income statement. Float increased as a consequence of GEICO’s additional business and from the acquisition of Swiss RE. (Swiss Re’s $2 billion Float is long duration float.) Buffett commented that in 2000 Berkshire’s Stock price was substantially below intrinsic value, that currently the market price is moderately below Intrinsic Value, but not as large a discount as it was in 2000. Derivatives Berkshire will make good profits on the puts and likely suffer some losses on the swaps. Berkshire modified the puts to a 10-year term down from 18-years and reduced the strike price to 994 from 1514. Munger commented that entering such derivatives contracts should have limits but that they were and are well short of that limit. He also said he thought the derivatives business is silly, unnecessary, and poor business practice. “Derivatives brokers basically sold bad products to clients.” Buffett and Munger both said with conviction that there’s a huge need for an overhaul of margin requirements. Buffett said that the creation of the derivatives markets basically undid the margin requirements put in place during the depression. Margin requirements were put in place for good reasons and the laws remain relatively unchanged. Few people would argue in favor of eliminating margin requirements. Derivatives however have allowed people to legally ignore margin requirements. Munger commented that our civilization has done unbelievably well without them (derivatives), that they (derivatives) are unnecessary and that they desperately need massive oversight. Munger said he supported hugely increased regulation of derivatives markets.

To put this into context: Derivatives are ok when strictly used for example, by producers to lock the future cost of some raw material. Otherwise they are a risk to the system and allow, rather promote, the use of huge leverage. Financial Companies Buffett highly recommended people interested in an overview of the mess, to read Jamie Diamond’s annual letter (JP Morgan Chase). I second his recommendation. It is a wonderful letter that I will highlight in a later article. Wamu and other unnamed banks had many clear signs of trouble. They were hugely leveraged, doing business that they should not have been doing. Credit card loss rates are (in general) apparently about 10% and they had in some cases increased the interest rates to 18%. Wells didn’t want tarp: But the government’s reaction was well warranted. Wells will be stronger in the end. (Much more so had none of this happened.) Wells is the low cost producer in the banking industry, 1.12% on deposits. The 4 largest banks had the same business model, but Wells Fargo followed a different model. Clayton’s Financing Gave an example that Clayton’s situation is similar to a situation at Goldman Sachs: unguaranteed loans (400 bp) vs guaranteed loans (100’s of bp less). So obvious disadvantages with respect to unguaranteed loans, but Clayton will adapt-for example, by partnering with certain institutions that have access to this much cheaper capital. Accounting Munger: “It’s terribly awful that accounting principles allow financial institutions to record increases in earnings as a consequence of their having significant reductions in credit quality.” That is, downgrades in bank credit ratings and general market uncertainty led to falling market prices for these banks bonds. Banks that had cash could buy their own debt at very large discounts to face value-allowing them to record an accounting profit. Government Buffett: Overall the Government did a good job considering the scale of the problems and speed with which they needed to react. There’s no way anyone could have satisfied all parties, and while there may have been better solutions (in hindsight) people (politicians and the public generally,) should be satisfied with the current outcome. Ratings Agencies: Housing (appreciation) optimism was built into the system. Credit agencies didn’t account for the possibility of loss. Their one size fits all checklist rating approach has obvious defects. AIG outrage over compensation was disproportionate to the realities of that situation. Health Care System Munger: Thinks something at least close to European Style is inevitable and that didn’t particularly horrify him (Analogy: Private vs. Public School). Munger did however wish that it would be put off for at least a year so energy can be focused on correcting the financial system. Housing Mid American owns the largest Real estate Broker in Southern California. The numbers are beginning to show some stabilization in medium to lower priced real estate. Higher priced real estate markets still erratic. The general situation The US had been increasing households by 1,300,000 per year, but housing starts were increasing at 2,000,000 per year. Currently we have overcapacity of about 1,500,000 million houses. About 2/3 of all owner occupied houses have a mortgage. Natural population and household growth relative to new housing starts (which is down, but far from zero) will reduce overcapacity by about 500,000 units per year. Meaning housing nationally will take a few years to fully stabilize. Buffett singled out his concern for real estate in South Florida, which he thought would have problems for some time. I’m of the impression that this has to do with Southern Florida’s lower average population growth (or household formations) with respect to the regions overcapacity. Similarly, neither Buffett nor Munger thought there would be a quick turnaround in retail or manufacturing especially those related to the housing markets. Buffett commented that Retail/Commercial Real Estate purchased at 5% premium Cap Rates will likely turn out to be silly purchases. The Cap Rate or Capitalization Rate is the income generated from the real estate property relative to the cost of the property (e.g. Annual net operating income / cost). The higher the price paid for the property the lower will be the cap rate. Purchasers who justified their purchase with a 5% cap rate were (likely) assuming that the value of their “prime” location would experience a greater than average increase in property value, which would make up for the low cap rate. Economy Buffett and Munger are intrigued by discussions and accusations that include the catch phrase, “Tax Payer dollars”. Taxes haven’t changed and no one has paid anything more than they had been. In reality, China and other purchasers of our governments fixed income securities (treasuries) will be the ones who will ultimately pay, not so much the “Tax Payer”. Inflation We will have some. Best guard against inflation is (i) your own purchasing power and (ii) owning or investing in good businesses. If you are the best at whatever your do, you will command a greater share of relative purchasing power. Inflation is unpredictable. But over the next 5, 10, 15 years the dollar will buy less or substantially less. We are however not alone. To offset the contraction of demand, the UK is running a deficit of nearly 12% of GDP and Germany is running a deficit of about 6% of GDP. That said a little inflation is not bad, just look at the last few hundred years. Moats Some moats that were thought, not too long ago, to be quite large and very sustainable, are deteriorating or have altogether disappeared. That is they’re filling up with sand. Example, Newspaper business: Reading the paper has lost its essential need with the coming generation and therefore businesses no longer find it an essential place to advertise. Board & Executive Compensation What’s needed? -Owners that are knowledgeable representatives. Buffett said, “Truth is that the Board has little affect on compensation, the CEO basically sets his own package.” Both Munger and Buffett suggested that compensation committees should be eliminated. Munger voiced that liberal pay to directors is counter-productive. It becomes club-like and the directors would do a better job if they were not paid at all. If the compensation is a large part of the directors well being (income) the director is not independent. Munger compared directorship to public positions (like congress). “No man is fit to be in such a position if he isn’t willing to leave it. Buffett, said to watch out for companies that need 100 pages to explain their compensation package. He also cited Chesapeake Energy as an example of egregious unwarranted compensation. Buffett” Compensation committees operate on the honor system: “Shareholders have the honor, Management, the system” BYD and China Munger called BYD “A damn miracle.” Business aspects: They are in rechargeable batteries, cell phone components, and Automobiles. To understand the capability of the company and specifically Wang Chuan-Fu, consider that they started literally from zero, with little to no capital, manufacture everything for their cars except the glass for the windows yet blew away the huge auto manufacturers with all their capital, resources, distribution channels, etc. New (lithium) battery technology is desperately needed not only for cars and obvious electronic devices, but also by utility companies-true domestically and globally. BYD, “Hit the sweet spot on that one.” Wang Chuan-Fu hand picks the best Chinese engineers, 17,000 or so to date. “The basic quality of the Chinese people is astounding.“ Munger said that the current Chinese economic policies are very much on point. “The most successful in the world. It’s a governments job to make their country hard to compete with and China has done that very well.” Matt Pauls Portfolio Manager Synthesis Partners, L.P. 4 North Park Drive Suite 106 Hunt Valley, Maryland Mobile 757.636.5998 WWW.ARCSTONECAPITAL.COM

Attending.

To begin with, ConocoPhillips meets all of Berkshire's requirements. Though he did say he made a mistake, what did was shot himself down before anyone else could criticize him. More importantly, he did not say he regretted the purchase. When attractive companies are available at attractive prices you buy them. His only concession was that he had purchased when oil prices were high-not that his purchase price of COP was too high.

I know little about this "fund" and I'm silly for making any sort of comment, but it appears as though they were and are heavily invested in commodity producers-which did very well as an industry. They look almost like an energy/mineral ETF to be honest. I doubt they will continue to do as well as they have in the past.

A quick run down of Leucadia National. See link below to download.

I'm not sure I follow the whole of your comments. Though, you're correct that derivatives classified as hedges don't go through earnings rather AOCI, but these very small with respect their total derivatives book.

Maybe I did't explain clearly. The following is largely from Richard Muller. Here are a few costs of energy per kilowatt-hour from various sources: Coal: 0.4¢ per kWh (coal costs $40 per ton) Natural gas: 3.4¢ per kWh (gas costs $10 per million cubic feet) Gasoline: 7.5¢ (at $2.50 per gallon; the price changes frequently) Car battery: 21¢ per kWh (the cost is the $50 per battery to replace) Computer battery: $4 per kWh (500 charges $100 per battery) AAA battery: $1000 per kWh (cost is $1.50 per battery) It's difficult to compare the costs of energy because different fuels and produce varying amounts of energy. Below provides a cost comparison in terms of electricity. Fuelmarket costcost per kWh (1000 Cal)cost if converted to electricity coal$40 per ton0.4¢1.2¢ natural gas$10 per million cubic feet3¢9¢ gasoline$3 per gallon9¢27¢ electricity$0.10 per kWh10¢10¢ For a good discussion on Electric Cars see: http://muller.lbl.gov/teaching/physics10/old%20physics%2010/physics%2010%20notes/Electric%20cars%20.html

The world is in desperate need of new super efficient battery technology. Right now to power a light bulb we pay something like, 10 cents per kilowatt hour (kwh). The cost per kwh to power a flashlight by the use of batteries, is something like $1000. The feasibility of Electric cars is questionable, but there may be other developments that come as a consequence of such a products development. I'd bet the money is in the battery, but who knows-we definitely don't know enough information. Buffett has been very consistent in allocating Berkshire's capital, but there have been times when a particular action causes confusion. This I suspect is one of those times.

Yes you can't use simply, http:// without the www. It must be, either http://www.berkshirehathaway.com or www.berkshirehathaway.com Also you might want to check out mozilla's firefox. Its a better web browser in my mind & safer. It can be downloaded free via: http://www.mozilla.com/en-US/firefox/personal.html or directly from: http://www.mozilla.com/products/download.html?product=firefox-3.0.8&os=osx&lang=en-US

e.g. ("(f) Derivatives Derivative contracts are carried at estimated fair value and are classified as assets or liabilities in the accompanying Consolidated Balance Sheets. Such balances reflect reductions permitted under master netting agreements with counterparties. The changes in fair value of derivative contracts that do not qualify as hedging instruments for financial reporting purposes are included in the Consolidated Statements of Earnings as derivative gains/losses.") -page 32, BH 2008 Annual-

I think you might reconsider your critique.

In response to: What is the effect of the new FASB ruling on mark to market? (Apr 2, 2009) If I correctly understand FASB’s revisions, it will allow banks to use more judgment in assessing the value of certain financial assets (e.g. CDO’s & other securitizations). As many of you know, there are 3 classifications that determine which inputs are used to calculate an assets “Fair Value”. Most securitized assets were level (tier) 2 and as such were calculated with respect to transactions of other similar assets. The market for these assets completely dried up except for forced or distressed transactions like Lehman. Meaning these distressed transactions drove down the Fair Value of other similar assets. The next step was to determine whether these impairments were “Other-Than-Temporary” in which case the otherwise unrealized losses became, for the most part, realized and thereby charged against income. This of course reduced banks regulatory capital. Insofar as banks are concerned there are two components to the impairment charge-Credit & Noncredit. Default would be credit, collapse in price due to illiquidity would be non credit. The accounting provisions will, in essence, lift the noncredit losses off the banks income statement. The noncredit losses go straight to Accumulated Other Comprehensive Income-a component of shareholder equity. With respect to Berkshire, I am of the opinion that there will not be a significant revision to their numbers. For clarity I’ll assume we are referring to Berkshire’s non-cash derivative losses. These losses were primarily linked to the Equity Index Puts ($5.3 billion) and CDS contracts ($2.3 billion-most of which related to high yield index). These contracts are liabilities. The price or cost to transfer the liability to another party is a financial liabilities Fair Value. The contract’s value is calculated at the end of each reporting period and is done under the assumption that it is either settled or otherwise disposed. When these derivative liabilities decline changes will only show up in the balance sheet as a decline in derivative liabilities and as an increase in equity via Accumulated Other Comprehensive Income. They will not show up in the income statement. That’s my rough take on the situation, but I may very well be wrong. For my own calculations I try to restate the accounting so that it’s as simple as possible, but ultimately makes economic sense from an owners perspective. Better to be roughly right.

Sorry this isn't specific to investments, but I think many of you will enjoy it. Archive.org (use the drop down to search) I start on this page: http://www.archive.org/details/additional_collections Its a free online library that offers pdf ebooks as well as mp3 audiobooks (human read). Notable audiobooks: Benjamin Franklin's Autobiography Adam Smith's Wealth of Nations

The answer to your question isn't an easy one. I'm sure you're aware of Berkshire's very complicated holding company structure. Subsidiary 'Z' might be owned by one or more other subsidiaries, (e.g. 51% by subsidiary 'X' & 49% by subsidiary 'Y'). In addition, their insurance businesses are constantly transferring assets between one another which makes identifying who holds which securities from year to year time consuming. Its similarly hard to say on a division to division basis where exactly certain assets are held. Ultimately I don't think this is too important-unless to offer peace of mind, but let's see if intuitively we can figure it out: The finance and financial businesses (as presented in the annual report) that would potentially write derivatives are: Berkshire Hathaway Credit Corporation, Berkshire Hathaway Finance, and Clayton. I'll assume everyone agrees that the equity index puts were written by Berkshire Hathaway Finance. Since cash received for the equity index put contracts are recorded in much the same way as insurance premiums (i.e. recorded as a liability) then the writer of the derivative contract would naturally record this as a liability on their financial statement, however, they may not be 'required' to hold the cash received therefrom at least not directly. To your question, I am almost certain that the equity index put float is invested by National Indemnity. Why? Berkshire Hathaway Finance Company's immediate parent is National indemnity. As everyone is aware, a controlling entity can often allocate capital as desired. In the case of certain restrictions (e.g. in the case of insurers only certain amounts may be paid out as dividends in any single period) there are ways for National Indemnity to invest this capital on behalf of Berkshire Hathaway Finance Co. (Entering into asset management agreements, etc.,). For reasons explained in 'the document' namely pgs 2-3, I referenced that these premiums were likely invested in, "Other Assets". As it happens, the GE & Goldman Preferred's have been invested and are held by National Indemnity. While we can't be certain that these investments were funded by Equity Index Put Float it would certainly make sense that the capital be allocated this way.

"Your analysis seems to imply that it is." Please elaborate.

It should disappear in investor's minds. Accounting numbers should be taken with a grain of salt-restating them to make sense from an owners perspective.

I've always said there is no investment approach that systematically outperforms the 'market' except for those that understand Ben Graham: e.g. those that purchase on the basis of underlying value relative to the price being offered. While Soros has done, as far as anyone can tell, very well indeed, he does not upon review appear to offer an investment approach that anyone can understand or replicate. Given many years of effort and a mutation of certain genes, understanding the most systematically successful investors i.e. those able to do increasingly well over longer periods and with increasing amounts of capital can be replicated, the same cannot be said of the investment approach which Soros claims to employ. I would bet large amounts that Soros is either a "closet value guy" or he just doesn't recognize that this is what is is doing. It may just be a way for him to avoid coattails. p.s. the term "Value investing" is redundant. Those that purchase on the basis of underlying value relative to the price being offered are investing, anything else is speculation.

p.s. "attached file" is hard to find. Here's a link for those with difficulty finding it: