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Buffet and his 35% american express position


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Its in one of the Buffett books, I forget which one - basically, AMEX was involved in a salad oil/water scam. Like any other financial institutions, if customers/users stop trusting AMEX and demand payables at the same time, AMEX was done for. Buffett became confident that AMEX had built up a loyal customer base based on his scuttlebug observations - he believed in the enduring nature of AMEX's franchise.

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Also at the time AMEX had a tremendous float in uncashed travelers checks (before ATM's and wide acceptance of credit cards.  Back in the olden days, when you traveled you bought AMEX or Bank America travelers checks or you were forced to carry a lot of cash.  After a trip we would keep a few for emergencies.

 

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Sometimes people miss the fact that Buffett's current Amex position was not established in the 1960s.

 

He bought 5% of Amex during the salad oil scandal and sold out in 1968, making around 30% annualized. At 22x earnings and 3x book, it wasn't a typical cigar butt. It was a play on credit cards which were a huge growth story. The credit card business was growing over 40% a year while the legacy travelers check business was growing around 10%.

 

In 1993 Berkshire bought 10% of Amex and has increased it since then.

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http://fundooprofessor.wordpress.com/2012/07/16/flirting-with-floats-part-ii/

 

"Between 1964 and 1966, Warren Buffett bet 40% of his partnership’s capital on American Express’ (Amex) stock, which had been battered down by the company’s involvement in the then infamous Salad Oil Scandal. Buffett’s investment of $13 million gave his partnership a 5% stake in the company, implying a total market cap of about $260 million at that time."

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At 22x earnings and 3x book, it wasn't a typical cigar butt.

 

Was that really the price he paid after the salad oil collapse??

 

Pretty close.  AmEx had 4,461,058 shares outstanding at the end of 1964.  1962 year end book value was $68 million. 1963 year end was $79 million.  1964 year end was $83 million.  At that time they had not taken a charge related to the scandal.  If Buffett paid around $40 per share initially he would have been buying at 2.2x book.  EPS in 1963 was $2.52 per share.  That means 16 times earnings.  Dividends were $1.40 per share.       

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At 22x earnings and 3x book, it wasn't a typical cigar butt.

 

Was that really the price he paid after the salad oil collapse??

 

Pretty close.  AmEx had 4,461,058 shares outstanding at the end of 1964.  1962 year end book value was $68 million. 1963 year end was $79 million.  1964 year end was $83 million.  At that time they had not taken a charge related to the scandal.  If Buffett paid around $40 per share initially he would have been buying at 2.2x book.  EPS in 1963 was $2.52 per share.  That means 16 times earnings.  Dividends were $1.40 per share.     

 

You're right. I was going off the fundooprofessor link which isn't the correct market cap.

 

It got down to around 15x earnings. He continued buying for several years as the price rose, so his average price was probably between 15 and 20x earnings.

 

I do think that the analysis focused on (non-Buffett controlled) float misses the point. Their competitive advantage wasn't float, it was the rapidly growing payment platform. The salad oil scandal actually showed that float was a weakness. They had so much float that it led them into bad commercial lending decisions.

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Wow so he really did pay up for a business in the 60s? I figured AMEX traded down to 3x earnings since that's all he was buying during that time.  I'm wondering how Buffett discounts growth and decides when to pay up for it. Paying for 20%+ growth and it doesn't materialize will lead to heavy losses.

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When looking at growth you need to look at the value they provide, and what other players can provide that value. And how much runway there is left. THen you can assess reasonably well with a margin of safety what kind of risk you are taking.

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Wow so he really did pay up for a business in the 60s? I figured AMEX traded down to 3x earnings since that's all he was buying during that time.  I'm wondering how Buffett discounts growth and decides when to pay up for it. Paying for 20%+ growth and it doesn't materialize will lead to heavy losses.

 

Growth isn't the only reason to pay a premium. Would you rather own Pet Rocks growing at 30% a year or Barbie growing at 10%?

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Mr. Buffett looked at the salad oil scandal as dividend check that went missing. What AMEX did is retained their reputation....earnings multiples do not apply at this time. Earnings power does.

 

He compared Bank of America's situation to this when he took his stake in them. The money spent by B of A to fix it's problems has already been paid out at other banks in the form of dividends. Bank of America's earnings power is still there as was Geico's.

 

Classic Buffett move right in front  of everyone's eyes....and most will miss it again .

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Mr. Buffett looked at the salad oil scandal as dividend check that went missing. What AMEX did is retained their reputation....earnings multiples do not apply at this time. Earnings power does.

 

He compared Bank of America's situation to this when he took his stake in them. The money spent by B of A to fix it's problems has already been paid out at other banks in the form of dividends. Bank of America's earnings power is still there as was Geico's.

 

Classic Buffett move right in front  of everyone's eyes....and most will miss it again .

 

Earnings power of BofA is about $2/share and Buffett picked up warrants with strike price of $7 for a 28% yield. He was getting a 6% earnings yield on AMEX, that’s a huge difference. He was banking on tech like growth. Remember this was in the 60s where decent companies were trading at 3x earnings.

 

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This is pretty well described in The Snowball, but it helps to see the annuals from the time. He was paying in the $40 region initially, when he first started accumulating in 1964. They earned $2.69 that year, or about $12.5 million, so he was paying right around 15x, as someone mentioned. I believe the low was $35, which would have been a market cap of less than $160 million in 1964.

 

But it took him a few years to put the full $13 million in. Alice writes that I took until 1966 for him to get 5% of the company. By then, Amex was earning $4 a share or about 19 million. So by the time the market cap had risen to 260 million, the price he was paying remained in the 13-15x sort of range.

 

And as we know, Amex was growing at nearly 15% per year, with a fairly unassailable franchise. Diners Club, Citi, BofA and others had tried to attack them and Amex still had dominant share in credit cards and travelers' checks. Despite charging premium prices all along for both its checks and its card.

 

So by 1966, it would not have been hard to argue Amex was worth something like $500 million, and Buffett had accumulated his stake at a market cap ranging from 150-250 million. The value was increasing every year.

 

The key insight was that Amex would continue growing the value of those franchises, while paying out much of its earnings in dividends, for a long long time. And that was a correct insight. Cha-ching!

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