tiddman

I would love to know how to do this -- earn a total of $1 million over 10 years and then have a net worth of $10 million. Does this involve playing Powerball? :)

There was a time in the early 90's I believe when Berkshire had more than 100% of its book value invested in equities, because it had invested in them using float. So it was in effect leveraged, both to the equities and the float itself. All forms of leverage magnify both upside and downside and can lead to forced selling or a wipeout. It is a matter of degree though. With broker margin you might be able to leverage yourself 2:1 which is pretty leveraged and can be dangerous. Working with float in insurance companies that you own can be safer, especially if you are more conservative, but a lot more know-how is required. BTW where can you borrow on margin at 1.5%? At TD Ameritrade the base rate is more along the lines of 7%.

A large portion of the funds for Buffett's investments come from insurance float, and there are restrictions on how much of that money can be invested in equities. Insurance regulations dictate that a substantial percentage of an insurance company's assets be in fixed income or preferred securities. I am not an expert in these rules but I know that a typical small insurance company can only invest 5-10% of its assets in equities. I have often thought that this is why Buffett makes so many investments structured as preferred + warrants, it is a way for him to meet the fixed income requirements of the insurance companies but also make an equity investment. However this is just an educated guess, I've never seen this spelled out anywhere. I am sure the equity index puts had an impact as well since those were losing value at the same time the market was, but again I am not sure exactly what capital this freezes up, if he did this through an insurance company or through some other means.

Frankly this sounds like a poor investment. Your friend probably wants out because he has to pay cash every month and can't figure out how to turn it around. If there were a way to decrease the property taxes he probably pursued that unsuccessfully. Its value is less than zero since it is not earning any money and has no prospects to do so. The value of a commercial property is based on the economic activity around it. If there aren't prospects for new businesses moving in or other economic growth then you'll just continue to lose money. I know that in DC for some blighted properties that have a lot of unpaid property taxes on them, new owners have sometimes successfully reached a settlement with the city to pay only a fraction of the overdue taxes. It might also be possible to petition the county to lower your appraisal value which would lower your taxes. But this cuts the county's revenue and they are not going to be willing to do that without a lot of fight and bureaucracy. You could also look into the zoning of the building and see if that can be changed, but this too is not easy.

Yes I thought that was a bizarre and disappointing sleight of hand. The time period has always been 5 years, and here without offering any explanation he suddenly makes it 6 years, which not-so-coincidentally includes 2008 when Berkshire had a huge advantage over the S&P. Berkshire has failed this test, and will surely continue to occasionally do so over time as it has simply become too large, basically I think it will fail to keep up in up markets. This will (or should) lead to a change in the company's dividend policy. I thought it would be better for Buffett to address this while he is still at the helm rather than let his successor break that news, and really thought this was going to be the year that he did it... guess not.

For me the very simple explanation is that, when the government bails out a company, it is reasonable for them to be repaid the funds required for the bailout plus some reasonable return. But it is not reasonable for them to simply take all future profits forever. There is plenty of precedent for bailouts even before this crisis, both in the US and in other countries. In the US the goal has been to bail the company out but then get it back on its feet, extract a pound of flesh, change management, and then return it to non-government investors. With the Fannie/Freddie bailout the US government changed the script and went from charging a 10% rate on the funds to simply taking all of the profits forever. This is clearly violates the spirit of capitalism that drives our economy. It is even more interesting when you consider that for a long time, banks were actually required to hold preferred stock in Fannie/Freddie on their balance sheets if they wished to do business with Fannie and Freddie. So the government required banks to hold these securities but then stepped in and made them worthless. There will be much debate and wailing and gnashing of teeth over what to do with the companies, but I don't think it's tenable to leave them in this quasi-shareholder-owned state and funnel all profits to the government forever. Whether or not the ultimate resolution provides value to shareholders or not is certainly speculative but if those profits don't go to the government, they have to go somewhere...

One of my highest conviction ideas of 2014 is Brookfield Asset Management (BAM), a company I don't see mentioned here very often despite the concentration of Canucks. BAM the stock was a laggard in 2013, up around 11% before dividends, but the business is doing quite well. I think the recovering economies in various regions around the world will benefit them, and in 2013 they finished restructuring the octopus so that they now have several pure-play publicly traded subsidiaries with BAM sitting top them collecting management fees. 2013 results were fantastic, but just like Berkshire and other investment companies, you need to treat one-time gains differently than recurring results. I think they are best valued on a cash flow basis rather than net income. This is high conviction for me because if the financial crisis wasn't a test of a leveraged asset owner then I don't know what is, and they went through the entire crisis unscathed. I think the underlying business provides a solid but unspectacular ROE (something like 12-13%) and they have opportunities to exceed this through deal making and other maneuvers. The focus on real assets should be beneficial in an environment with inflation, increasing energy prices, or both, and I suspect we are going to see both of these over the next 5+ years.

Sorry, I wrote that a while back when the stock was much cheaper :). I should have put a date on it.

A little off topic but here is a synopsis of BOBS that I wrote in another forum recently. BOBS is the 2nd largest burger chain in Brazil, second to McDonald's. The Brazilian economy has a very colorful 20 year history including high inflation, unstable currencies, dictators, and general chaos. Recently the economy has stabilized, it missed the worst of the global meltdown because leverage was basically unavailable, its debt is now investment grade, they are running a trade surplus, interest rates are dropping, and investment is increasing. Brazil has a young, increasingly affluent population. The Brazilian Real was one of Buffett's currency bets and one of the last ones he sold. My view is that Brazil will continue to stabilize and become a reasonably productive economy. Fast food has low penetration in Brazil, and if the trends that have taken hold elsewhere in the world get started, Bob's would benefit from that too. The Bob's chain was founded in 1952 by the American Brazilian tennis champion Robert Falkenburg. It started out with a single restaurant in his neighborhood but has expanded to over 650 locations. They have a simple menu of burgers, fries, milkshakes, etc. with an average ticket of about US$4.50. Historically they have owned the restaurants, but since 1984 been growing primarily through franchising, which is what makes the story interesting, and distantly relevant to SNS. In 2008, owned restaurants provided 73% of revenues but nominal operating income (operating margins 0.4%). Franchise locations provided 18% of revenue and almost all of the operating income (operating margin 72%). At YE 2008 they had 642 locations, of which 62 are owned and the remaining 580 are franchised. Their goal is to grow primarily through franchising going forward and are targeting 720 locations by YE 2009. In August 2008 they acquired YUM's largest Pizza Hut franchise in Brazil with 14 locations, funded with debt. http://www.businesswire.com/portal/site/google/?ndmViewId=news_view&newsId=20080812005307&newsLang=en An exec named Jorge Aguirre came with the deal, who is apparently quite the fast food magnate in Brazil, who has evidently worked for all of the large fast food companies in the country. He is credited with turning around YUM's franchises over the past 10 years by addressing the cultural and operational issues that come with introducing foreign fast food to the Brazilian market. Here is some background on his history: http://www.bizlink.ufl.edu/pdf/risner.pdf The company also has various other JV's it's working on, generally 60/40 deals to add locations, all in the fast food area. The stock trades OTC and is currently at around $3.20 and a market cap of $26M. CFO in Q1 was about R$5.5M which is about US$3.0M. MRQ book value is about US$11M, so they're at around 2.5x book, typical for a franchisor. They report in Brazilian Reals but file K's and Q's with the SEC as they are ultimately a holding company.

Brookfield Asset Management (BAM) and their subs have a big presence in Brazil. They own land, commercial and residential developments, hydro power, and some other assets. I think they are the largest operators of shopping malls. They have a long history there dating back decades, the former name of the company was Brascan which stood for "Brazil-Canada". Buying BAM exposes you to a lot of things besides their Brazil assets, but by poking around you could find their REIT's, trusts and other publicly traded entities with more direct exposure. Brazil has a history of high inflation, unstable currency, and the occasional economic collapse, but about 10 years ago they seem to have gotten their house in order. Their interest rates have always been very high (reflecting high inflation) but in April 2008 their debt was raised to investment grade for the first time. Since then rates have come down, foreign investment has increased, as has the ability to finance assets. This is driven by a very strong export economy. You may recall that the Brazilian Real was among the currencies that Buffett bought a while back when he was hedging against the US Dollar, and I think this was the last of the batch to be sold. Another way to play this is with Brazil Fast Foods (BOBS on the bulletin boards), a large (for Brazil) hamburger chain there. The company's history is a saga similar to that of the Brazilian economy and makes for very interesting reading.

In essence, the drive-through business model has much higher margins than the sit-down and eat model. Imagine you had a restaurant with 5 employees and every guest came in to sit down and eat, they might spend 30-60 minutes eating so with a staff of 5 you could serve maybe 5-10 groups per hour. Now imagine your business was 100% drive-through. Those 5 employees would just be preparing and bagging food, collecting money, etc. so you could serve dozens of guests per hour. Your cost per guest is much lower so the margins are much higher. For example this is from the Sonic web site: SONC's net margins are around 16% (i.e. net operating income divided by revenues). By comparison, Steak'n Shake is primarily a sit-down restaurant, and their net margins were 1% in 2009, and their owned restaurants historically run net margins of around 4% max. SONC carries higher debt but this debt is supported by the margins and cash flows from the business. I haven't really evaluated it as an investment, I would look at the price paid vs. the cash flows and what potential they have for growing those cash flows. The fast food / drive-through business is very competitive in the US and while they have a strong brand, there are a lot of competitors.

Maybe it depends on where you draw the line between the insurance and investment ops (which are inherently part and parcel with one another). The typical insurance company underwrites at a small loss (say 2-5%), has investments equal to about 2-3x book value, debt-to-equity of around 25%, and earns a yield of about 4-5% on those investments, which are usually almost exclusively in safe bonds. This leads to an ROE of maybe 10-12% when nothing goes wrong, and, on average, something goes wrong once every 5 years or so. This leads to a nonzero but unimpressive return over the long term. The place where Fairfax differs from this model is in the investment returns which are much higher, and higher overall leverage due to use of debt. The insurance operations are, over the long term, basically average. The leverage can be dangerous and has gotten them in trouble in the past but is probably manageable they way they are now. But the investment returns, in both stocks and bonds, is the major differentiator, which is what makes it an attractive investment IMHO.

If it were possible to invest in just the equity portion of Watsa & Hamblin's investments, I would eagerly do that... without leverage and for the long term. Their track record there is fantastic. I wouldn't pay more than NAV though... that defeats the goal of obtaining the superior returns. But at Fairfax, you have to take the fixed income and insurance operations along with the equity investing, plus leverage, plus exposure to super-cats. This package is not quite as appealing to me as just the straight equity investments but should provide solid returns... but only if I pay book value. I am probably in the minority here but I don't feel that Fairfax is worth a big premium to book value, and history has shown that there are ample opportunities to buy it below book, so I don't see any reason to pay a premium.

The Fairholme fund fell about 30% in 2008. If they had been levered 3 to 1 or 4 to 1 shareholders would have been completely wiped out... the leverage works both ways. You can't just say that a great manager is more great if you apply leverage. That only works during the good times. Gee I don't remember saying anything of the sort :). Fairfax's insurance operations, exclusive of investments, are approximately average in terms of long term results and will probably remain so. Average insurance operations with average investment results are worth book value or slightly less (look at WTM at 78% of book for example). What differentiates Fairfax is the investment returns. The results from Watsa & team are fantastic. But I am not willing to pay a 50% premium to book for that, because if I did, their fantastic results would lead to average results for me. I would rather pay book value, and get the fantastic results for myself.

Paying 1.5x book for Fairfax based on the investing acumen of Watsa & his team is similar to paying 1.5x book for a mutual fund. Would you pay 50% above the current quote for the Fairholme fund because of the investing acumen of Berkowitz and his team? Why not?

I think that part of the strategy must be to issue stock for these purchases. Even after recent declines, BH stock is trading at around 1.4x book. If BH issues new stock to make these buys, it is accretive to BH's book value. I suspect that the funds and entities within BH are making the purchases with cash, and then tendering the stock to BH in a tender offer. So the underlying investment might not be all that important to the overall strategy, as long as the stock doesn't move around a lot between when they buy and tender. They may also hedge their position by shorting the stock when they buy it. This is all just a guess... but it does help to explain why they repeatedly make these minority purchases followed by tender offers.

... for Buffett, but not for most people. You also need a lot more money to invest in order to become wealthy with stocks than with other assets. Buffett started with $100, and if he were only investing his own money, even at 21% per year for 50 years he'dl have "only" around a million dollars. The way that Buffett got wealthy was by the leverage effect of investing other people's money. Real estate investing provides another form of leverage, which in some ways is riskier but also easier for the typical person to obtain. I know a lot more people that have become wealthy via real estate than by the stock market.

Not sure if you are kidding or serious... but new illegal immigrants have been estimated in the 500,000 per year range for the past few years, while the overall population is growing at about 5-7x that. And many of those illegals later become legal, and most of them are employed (which is usually the reason that they came to the US to begin with). I don't think the country is at risk to be overrun with unemployed illegal aliens. I tend to agree, and with the military spending, the US is basically taking a mortgage on its future in order to finance the wars of today. I am not sure if they will ever reap any kind of economic benefit that would offset this spending. However, it was less than 10 years ago that the US ran a budget surplus... for 4 years running in fact, and it didn't take wild inflation to get there. I think looking at the deficit in a deep down cycle in the economy and assuming that it will remain there forever is a mistake. Look at it this way. Generally, over long periods (10+ years), real estate that is in economically successful areas appreciates at somewhere around 3-8% per year long term. You can safely buy such an asset with leverage up to 4:1, probably 3:1 with more safety. With 5% appreciation and 3:1 leverage that is a 15% long term return, and real estate has a natural inflation hedge. I can see how that can be attractive. This applies to a single unit residential property or an office tower. Many REITs invest for yield instead of appreciation, and I agree that a cap rate of 4.4% is too low -- that is lower even than the cap rates at the market peak in 2006. A cap rate of 6-8% is probably more safe/reasonable.

I think one important difference between the Japanese and US economies that is often overlooked is population growth. Japan's population has been flat for nearly as long as their economy. This is certainly not the sole cause, but I think it is related. In the US, the population has growth at about 2-3% per year for a long time and will probably continue to do so. Unless all of these new people entering the work force immediately join the ranks of the unemployed, the US economy should grow at close to this rate each year. The US has its own issues with deficits, military spending, leveraged consumers, etc. but for the economy to move sideways for 10+ years, I am not sure what the work force would look like at that point -- unemployment of 10-20%?

I think it is interesting that you have two camps of people, one arguing that the risk is inflation, another that the risk is deflation, and they are each convinced they are right and have a lot of supporting data. If I had to bet I'd agree more with Watsa than others, though I think he is drawing too much of a parallel between the US and Japan. I think that some of the people worried about inflation are motivated by a distaste for the government bailing and spending programs that were enacted to stem the crisis, they aren't really concerned about inflation per se but are speaking out about government intervention indirectly by complaining about the risk of inflation. The US government is actually doing pretty good on its bailout funds... they borrowed money at near 0% (at times less than 0%) and loaned it out at about 5-15% plus equity kickers. US tax payers will actually profit from most of these bailouts, rather than be required to fund them. No inflation there.

Strictly speaking, paying down debt doesn't increase book value... it uses an asset (cash) to eliminate a liability (debt) which is neutral to book value. Paying down the debt would allow Berkshire to decrease its debt ratio and maybe regain its AAA credit status. I am sure that Berkshire will do fine but not fantastic long-term with BNI. More importantly I think the increase in rail volume is a positive indicator for economic recovery.

There was an article at The Motley Fool just a few weeks ago which cited a rail report and concluded that rail traffic might be on track to fall by 25% this year. http://www.fool.com/investing/general/2010/06/17/buffetts-favorite-indicator-points-down.aspx However, this article from the same report has a more favorable view: http://mjperry.blogspot.com/2010/06/rail-traffic-continues-to-improve.html I am sure that Buffett follows these numbers and those from his other businesses closely, and can use that to gauge the strength of the economy and where it is in the recovery process. About 9 months before economists said we were in recession, Buffett did, probably based on the same kind of numbers. Now, he is saying that we are certainly in recovery, though other analysts aren't saying that yet. Hey maybe the old guy knows something?

There is a statistic (not sure of the accuracy) that 78% of NFL players go bankrupt within 2 years of retirement. For instance: http://sportsillustrated.cnn.com/vault/article/magazine/MAG1153364/index.htm This makes the whole cycle of sports players becoming stars seem kind of pointless, since they are basically a conduit for money transferred from fans to purveyors of luxury goods. Has LeBron elaborated on why he wants to become a billionaire? Why isn't being a millionaire enough?

Well I can see two sides of the issue. Warren Buffett and many other successful people often say "do what you love". I think it would be hard to make the case that being an associate insurance claims adjuster is something that you can really fall in love with. At the same time, when you're in your early 20's and just starting out, you can't be too choosy. Entry level jobs are often unglamorous at best, so sometimes young people need a kick in the pants to get started. But who is to say that starting out by entering the corporate world is the best choice? I could also question the wisdom of spending a bunch of money to send your kid to an expensive liberal arts school to get a degree in political science and then just expect job offers to fall from the sky. In this case the parents must take most of the responsibility. If your goal is to become employed as effectively as possible, there are many other, better choices. Here is another sad story of a young woman who ran up $88k in student loan bills and then discovered that she couldn't get a job. http://www.postgazette.com/pg/09244/994533-68.stm Her degree was in "liberal arts" which apparently didn't improve her job prospects even though she spent a lot of money. This is another thing that people don't often consider, they should look at college expenses in terms of return-on-investment rather than just something they are compelled to do. But if entry level corporate jobs seem boring, perhaps the unemployed young'un could consider other pursuits that would be interesting and rewarding even if it doesn't bring in any money, such as joining the Peace Corps, volunteering for some socially responsible cause, or heck just traveling around the world for a year. I don't think anyone ever did anything worth mentioning by sitting on the couch for 2 years.

IMHO Microsoft has lost whatever initiative they ever had. I think that the only thing that has driven their success over the past 10+ years was their monopoly position in desktop OS. This gained them their entry into the business market and also allowed them to establish Microsoft Office as a standard. All of the claims made during the anti-trust trials about Microsoft "tying" their products to their core OS were dead on. Their only successful products are those that were tied to the OS, and were only chosen by consumers when consumers didn't have any other choice. The company is now clearly adrift strategically. The Kin debacle is one of many examples. They can probably continue to coast on their past success for a while, maybe a long time, but I think their days of growing substantially are over.