Buffett/Berkshire - general news

[Xerxes]

https://www.bnnbloomberg.ca/berkshire-hathaway-showing-signs-of-an-appetite-ahead-of-earnings-report-1.1476873

 

Sell side estimate is $6 billion share buyback

[gfp]

We sort of already know it is less than that through quarter end since the filing that telegraphed the ~$5.3-5.4 Billion in buybacks was in July.  But maybe analysts are looking for a to-date and not quarter-end figure.

[John Hjorth]

We'll know for sure tomorrow [at some time, depending where you are], right?

[Liberty]

https://brooklyninvestor.blogspot.com/2020/08/is-buffett-really-bearish.html

[Cigarbutt]

https://brooklyninvestor.blogspot.com/2020/08/is-buffett-really-bearish.html

Interesting, as always.

From the link:

"It is amazing to think it was above 100% before the Gen Re merger. BRK back then was a leveraged play on Buffett's stock-picking skills, and any investment in bonds offered free incremental points on ROE above all that. No wonder why returns were so high back then."

"So, this piece of evidence doesn't really show any bearishness on Buffett's part, or at least compared to the last 20+ years."

i submit that two considerations should be kept in mind:

The previous era referred to was before the 1996 irrational exuberance speech.

The next twenty years may be very different from the last ones.

i don't see why BRK would not become a leveraged play again, given the right circumstances.

[wabuffo]

i don't see why BRK would not become a leveraged play again, given the right circumstances.

 

Is it possible we have gotten the idea of insurance float all wrong?  Despite Buffett's denial, brooklyninvestor highlights powerful evidence that BRK typically holds cash and fixed income amounts roughly equal to total insurance float, year-in and year-out.

 

In my BRK valuation models (variation of 2-column method), I've always deducted 20% of total float as non-working capital from total after-tax value of investments per share) to get my fair value estimate.  But what if it is really 100%?  Then my fair values have been overstated (and so have everyone else's).  When I try this adjustment (20% to 100%), my fair value estimates go from BRK being perpetually undervalued to BRK being mostly fair-valued with just a few periods of slight undervaluation (eg. 2015-16).

 

This approach would be consistent with Buffett's methodology going all way back to Blue Chip Stamps.  I always assumed that Buffett redeployed BCS's cash and fixed income investments into an investment in See's Candy - but that's not what actually happened when I got my hands on the annual reports.  Instead, Buffett used the unredeemed stamp liability as pseudo-equity and levered up the balance sheet to buy Sees.  He didn't really touch BCS's investment portfolio - other than tinkering with some of the fixed income investments for a bit of higher yield.  It was only many years down the road, when it was clear the redemption liability was wildly overstated (and in fact the IRS began prodding BRK to take profits (and pay income taxes) on the "breakage" that Buffett really began to redeploy/shrink the investment portfolio.

 

It is a bit of an a-ha! moment for me given the blog's reminder and my recent acquisition of the old BCS financials.  I'm gonna have to go back and re-tool my BRK valuation models.

 

wabuffo

[thepupil]

https://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/i-hate-this-post/msg235122/#msg235122

 

There was an extensive argument / discussion about this in 2015. I was arguing along the lines of you and cited Brooklyninvestor’s work as evidence.

 

Then Berkshire deployed a large chunk of its cash to buy PCP and continued to reiterate they had more cash to deploy and I revised my view that Berkshire held 100% of float in cash/short term fixed income (to something lower) Since then of course, cash and FI has built back up

 

I think it’s fair to say that Berkshire can deploy a bunch of capital at once if there’s an opportunity, but that the steady state is excessively capitalized / about 100% of float (or more) in cash/FI. This creates some quasi permanent cash drag on steady state ROE, but also increases safety as I don’t think all of it is required by regulation or anything like that.

[changegonnacome]

i don't see why BRK would not become a leveraged play again, given the right circumstances.

 

Is it possible we have gotten the idea of insurance float all wrong?  Despite Buffett's denial, brooklyninvestor highlights powerful evidence that BRK typically holds cash and fixed income amounts roughly equal to total insurance float, year-in and year-out.

 

In my BRK valuation models (variation of 2-column method), I've always deducted 20% of total float as non-working capital from total after-tax value of investments per share) to get my fair value estimate.  But what if it is really 100%?  Then my fair values have been overstated (and so have everyone else's).  When I try this adjustment (20% to 100%), my fair value estimates go from BRK being perpetually undervalued to BRK being mostly fair-valued with just a few periods of slight undervaluation (eg. 2015-16).

 

This approach would be consistent with Buffett's methodology going all way back to Blue Chip Stamps.  I always assumed that Buffett redeployed BCS's cash and fixed income investments into an investment in See's Candy - but that's not what actually happened when I got my hands on the annual reports.  Instead, Buffett used the unredeemed stamp liability as pseudo-equity and levered up the balance sheet to buy Sees.  He didn't really touch BCS's investment portfolio - other than tinkering with some of the fixed income investments for a bit of higher yield.  It was only many years down the road, when it was clear the redemption liability was wildly overstated (and in fact the IRS began prodding BRK to take profits (and pay income taxes) on the "breakage" that Buffett really began to redeploy/shrink the investment portfolio.

 

It is a bit of an a-ha! moment for me given the blog's reminder and my recent acquisition of the old BCS financials.  I'm gonna have to go back and re-tool my BRK valuation models.

 

wabuffo

 

Hi Wabuffo - very interested to see your fair value estimate for BRK under those assumptions.

[rolling]

i don't see why BRK would not become a leveraged play again, given the right circumstances.

 

Is it possible we have gotten the idea of insurance float all wrong?  Despite Buffett's denial, brooklyninvestor highlights powerful evidence that BRK typically holds cash and fixed income amounts roughly equal to total insurance float, year-in and year-out.

 

In my BRK valuation models (variation of 2-column method), I've always deducted 20% of total float as non-working capital from total after-tax value of investments per share) to get my fair value estimate.  But what if it is really 100%?  Then my fair values have been overstated (and so have everyone else's).  When I try this adjustment (20% to 100%), my fair value estimates go from BRK being perpetually undervalued to BRK being mostly fair-valued with just a few periods of slight undervaluation (eg. 2015-16).

 

This approach would be consistent with Buffett's methodology going all way back to Blue Chip Stamps.  I always assumed that Buffett redeployed BCS's cash and fixed income investments into an investment in See's Candy - but that's not what actually happened when I got my hands on the annual reports.  Instead, Buffett used the unredeemed stamp liability as pseudo-equity and levered up the balance sheet to buy Sees.  He didn't really touch BCS's investment portfolio - other than tinkering with some of the fixed income investments for a bit of higher yield.  It was only many years down the road, when it was clear the redemption liability was wildly overstated (and in fact the IRS began prodding BRK to take profits (and pay income taxes) on the "breakage" that Buffett really began to redeploy/shrink the investment portfolio.

 

It is a bit of an a-ha! moment for me given the blog's reminder and my recent acquisition of the old BCS financials.  I'm gonna have to go back and re-tool my BRK valuation models.

 

wabuffo

While I have noticed that for a while, it is fair to say that excess cash also reduces risk. IMO it reduces an equity investment to a bond like risk. This would mean you should use a bond like discount rate also. As such fair value really is not lower due to that. (Un)Fortunately that also means undervaluation is permanent (since bond investors are unlikely to invest in equities (even if risk is lower and return higher).

[wabuffo]

Hi Wabuffo - very interested to see your fair value estimate for BRK under those assumptions.

 

Sure thing - always happy to share.  I haven't updated my model in a while so these are annual numbers for 2010-2017.  This helps keep everything consistent because I use a pre-tax multiple on operating earnings and this period had a consistent Federal corporate tax rate of 35%.  If I update, I will have to think about how to handle the change to a 21% tax rate. 

 

Anyhoo - just some quick background. 

Value of Operating Businesses:

To the pre-tax earnings of the operating businesses, I add a long-term expected underwriting profit on insurance float that is in-line with the last 10-15 years performance (ie, 0.5% for BRK Re/Gen Re, 6% for GEICO and 5% for Other Primary).  Excluded are all investment gains/losses and derivative gains/losses.  I then use a 10x multiple on pre-tax earnings.

Value of Investments:

After-tax value of all investments (I subtract capital gains taxes).  This is where I subtract the non-working part of the insurance investment assets.  I typically used 20% of float (based on what Buffett says) - but I also show a second model with 100% (based on what Buffett does).

 

[Click on image for full-screen view.]

 

As I said in the earlier post - this was an a-ha moment for me.  (apologies for missing the discussion from that 2015 thread - better late than never)  I guess the key insight is that if the assumption that Buffett really does maintain 100% coverage for float via cash/fixed income securities, then BRK goes from perpetually undervalued (67%-88% of the model's central value for BRK-B) to closer to always fairly-valued (82-107%).

 

As always - criticism and feedback always welcome.

 

FWIW,

wabuffo

 

[changegonnacome]

Very interesting - thanks

[Cigarbutt]

Sure thing - always happy to share.  I haven't updated my model in a while so these are annual numbers for 2010-2017.  This helps keep everything consistent because I use a pre-tax multiple on operating earnings and this period had a consistent Federal corporate tax rate of 35%.  If I update, I will have to think about how to handle the change to a 21% tax rate. 

Anyhoo - just some quick background. 

Value of Operating Businesses:

To the pre-tax earnings of the operating businesses, I add a long-term expected underwriting profit on insurance float that is in-line with the last 10-15 years performance (ie, 0.5% for BRK Re/Gen Re, 6% for GEICO and 5% for Other Primary).  Excluded are all investment gains/losses and derivative gains/losses.  I then use a 10x multiple on pre-tax earnings.

Value of Investments:

After-tax value of all investments (I subtract capital gains taxes).  This is where I subtract the non-working part of the insurance investment assets.  I typically used 20% of float (based on what Buffett says) - but I also show a second model with 100% (based on what Buffett does).

[Click on image for full-screen view.]

As I said in the earlier post - this was an a-ha moment for me.  (apologies for missing the discussion from that 2015 thread - better late than never)  I guess the key insight is that if the assumption that Buffett really does maintain 100% coverage for float via cash/fixed income securities, then BRK goes from perpetually undervalued (67%-88% of the model's central value for BRK-B) to closer to always fairly-valued (82-107%).

As always - criticism and feedback always welcome.

FWIW,

wabuffo

Here is some feedback (and critcism). :)

1- The tax issue is interesting. i guess you'll have to differentiate what you think should be the rate and what it will be and we might as well stay out of this conversation.

2- The basic and fundamental issue is a recurrent theme and is related to the argument about the extent of discounting of the reserves one should apply (and by logical extension, if applicable, what premium on book value to apply with acquisition) when float is expected to grow profitably. So an argument could be made that the pre-tax multiple you are using is too low for the expected performance at BRK insurance subs going forward, in terms of the cash slows that will eventually be generated.

3- You seem to rule out the possibility that the "coverage" of liquid investments to float moves away from 1 (below 1). There is a possibility that this ratio could come to 0.8 or even lower going forward, given the right circumstances. IMO, there is an unrecognized option value on this variable liquidity. On this Board, it's sometimes mentioned that people would use relative valuation in real downturns (those used to happen before) ie they would sell stuff like BRK which, in theory, would resist better in order to buy more undervalued securities. For BRK, this would imply to sell fixed income securities almost guaranteed to maintain (real) value (cash, cash-equivalent, extremely low duration US government debt securities) under any circumstances in order to buy securities on sale. That would certainly act like a multiplier on the change of the "coverage" ratio.

4- You seem to assume that the fixed income part is non-interest bearing and will always be. While this is basically true now, as Mr. Buffett's cash (0 duration) and fixed income (low amount and duration) positions point to the very least as a protection against rising rates (the new Barrick Gold would support this hypothesis as the appearing point of the iceberg), the fixed income side of the portfolio may become a very reliable and enduring source of additional returns on capital. You don't seem to comment on Fairfax but i would say that the historical return on the fixed income part of the portfolio (at least up to the recent period and even if not generally recognized by the investing community) has been a large contributor to the return on equity over time and this could become the case also for BRK if the risk-reward profile becomes favorable. Also, the fixed income portfolio of an insurance firm is a form of a leveraged bond fund.

In conclusion, i submit that your 100% non-working capital assumption is too conservative.

[wabuffo]

CB - I love your feedback (and criticism)

 

The tax issue is interesting.

 

Yeah - I think its a big deal.  I am in the process of bringing my little model to present day and will use a 12.15x multiple on pre-tax earnings at a 21% federal corporate tax rate (instead of 10x at 35%).  That way the implied value on the after-tax earnings are on the same basis.

 

You seem to assume that the fixed income part is non-interest bearing and will always be.

 

Well - who really knows.  I think that, whether we like it or not, MMT concepts are beginning to take hold as the non-MMTers running the Federal government learn through trial and error that the fiscal capacity of the US Treasury is much larger than anyone previously thought. Therefore, I think that the Federal government will essentially stop paying any interest at all.  In fact, as we discussed on the other macro thread about banks - the Federal government doesn't really have to issue debt at all.  It only does so because (a) its General Account at the Fed can't be overdrawn by statute, and (b) bank reserves at the Fed would grow too large - so it will do the next best thing and just pay close to zero rates on Treasuries (while still holding to constraints a) and b)).

 

You seem to rule out the possibility that the "coverage" of liquid investments to float moves away from 1 (below 1). There is a possibility that this ratio could come to 0.8 or even lower going forward, given the right circumstances.

 

You could very well be right and there's some evidence that Buffett takes the ratio down to 80% coverage temporarily in order to accomodate large acquisitions (see PCP).  But he quickly restores it to 100% via operating cash flow from what I can see.

 

As I said in the earlier post, I was always aware of brooklyninvestor's 100% float coverage data, but ignored those findings because I attributed them to BRK's immense capital base and a lack of actionable investment possiblities.  I assumed that when Buffett was younger and more of a swinger, there's no way he would hold so much cash.  Blue Chip Stamps (BCS) would've been a better example of his "float management" principles given that it was the 1970s and Buffett was quoted by Forbes as feeling like he was an oversexed man in a ....well, you know the quote  8). 

 

I thought - for sure, Buffett would've deployed all or most of BCS's investment assets into Sees, Wesco and the Buffalo News even as he maintained the liability for the trading stamps because he had "more ideas than capital".  Remember this is a period with three savage bear markets - 1973-74, 77-78 and 81-82.

 

But when I looked at the financials after I got them last month, that's not what he did.  He borrowed against the pseudo-equity of the stamp liability and maintained the investment assets to cover the potential trading stamp redemption requirements.  Sure it occasionally dipped down to 80% as BCS took some hits to its portfolio in 1977 just as Buffett/Munger were buying the Buffalo News - but it quickly rebounded to 100%.  This even as by the early 80s, it was clear that the vast majority of the trading stamps liability was never going to be redeemed (you can see this as revenues plummeted while the liability for redemption didn't change at all).

 

Here's the quickie-table I drew up comparing Blue Chip Stamps investment assets vs trading stamp liabilities:

 

I think perhaps we've always underestimated how much of an extreme-safety stance Buffett takes when it comes to float.  Like I said earlier, this changes everything.  It essentially makes all this $130B in insurance float worthless (especially in this environment of zero rates 4ever).  And the idea of bagging a $100B+ "elephant" becomes a total fantasy (unless Buffett wants to get hyper-aggressive with debt).

 

Even if we take 80% (instead of 100%) of investment float as conscripting cash and fixed income securities into being non-working assets, it becomes clear that all the two-column models out there (Tilson's, Semper Augustus, etc) are a mite too optimistic in their intrinsic value read-outs. 

 

That's not a terrible outcome.  BRK doesn't go from always being undervalued to Tesla-crazy overvaluation.  For the most part, its central value drifts a lot closer to Mr. Market's valuation - though still a tad under that daily quotation on most days.  The key is to watch what Buffett does (and not what he says).

 

wabuffo

[Munger_Disciple]

He borrowed against the pseudo-equity of the stamp liability and maintained the investment assets to cover the potential trading stamp redemption requirements.

 

Wabuffo,

 

Excellent analysis of BCS float!

 

Do you think the banks that gave loans to BCS for purchase of businesses like See's and Wesco ignored the stamp liabilities and just looked at metrics like EBITDA? It appears Buffett mostly funded the purchase of businesses in the 70s with debt without touching the marketable securities which were earmarked for stamp redemptions. But it seems he did get the (perhaps indirect) benefit of float because the reason he was able to fund 100% of purchase price in some cases (ex. Buffalo News) with debt was due to the highly liquid balance sheet. If the reasoning is correct, then the main advantages of zero cost float are:

 

(1) income that can be generated with (mostly short term, highly rated) bonds, and

(2) the ability to raise funds for large acquisitions via new debt issuance.

Given the zero interest rate/MMT environment we live in, the first advantage goes away. But the second advantage remains. * (see below) If interest rates turn negative, (1) becomes a liability.

 

Interestingly BNSF purchase was partly funded with Berkshire stock and debt (rather than dipping into liquid funds for earmarked for insurance liabilities).

 

*Interest rates were much higher in the 70s so the cash equivalents on BCS balance sheet were generating significant income which was used to raise debt for purchases of wholly owned businesses. Given the zero interest rates, this is no longer the case.

 

-MD

[Cigarbutt]

...

I thought - for sure, Buffett would've deployed all or most of BCS's investment assets into Sees, Wesco and the Buffalo News even as he maintained the liability for the trading stamps because he had "more ideas than capital".  Remember this is a period with three savage bear markets - 1973-74, 77-78 and 81-82.

 

But when I looked at the financials after I got them last month, that's not what he did.  He borrowed against the pseudo-equity of the stamp liability and maintained the investment assets to cover the potential trading stamp redemption requirements.  Sure it occasionally dipped down to 80% as BCS took some hits to its portfolio in 1977 just as Buffett/Munger were buying the Buffalo News - but it quickly rebounded to 100%.  This even as by the early 80s, it was clear that the vast majority of the trading stamps liability was never going to be redeemed (you can see this as revenues plummeted while the liability for redemption didn't change at all).

 

Here's the quickie-table I drew up comparing Blue Chip Stamps investment assets vs trading stamp liabilities:

 

I think perhaps we've always underestimated how much of an extreme-safety stance Buffett takes when it comes to float.  Like I said earlier, this changes everything.  It essentially makes all this $130B in insurance float worthless (especially in this environment of zero rates 4ever).  And the idea of bagging a $100B+ "elephant" becomes a total fantasy (unless Buffett wants to get hyper-aggressive with debt).

 

Even if we take 80% (instead of 100%) of investment float as conscripting cash and fixed income securities into being non-working assets, it becomes clear that all the two-column models out there (Tilson's, Semper Augustus, etc) are a mite too optimistic in their intrinsic value read-outs. 

 

That's not a terrible outcome.  BRK doesn't go from always being undervalued to Tesla-crazy overvaluation.  For the most part, its central value drifts a lot closer to Mr. Market's valuation - though still a tad under that daily quotation on most days.  The key is to watch what Buffett does (and not what he says).

 

wabuffo

Let's leave the spacious fiscal room and MMT concepts aside for now (there is a separate contaminated addition inserted at the end) as negative interest rates have entered the territory of casual conversations.

---

Two aspects i disagree with concerning the possibility that BRK could become, to some degree, a leveraged (both debt and especially float) play again.

 

On the debt aspect, BRK has used debt opportunistically in the past, under various scenarios. For example, in the early days, Diversified Retailing carried high debt and Blue Chip Stamps (BCS) also, as mentioned above, used debt. While BCS used See's, then Wesco and marketable securities as collateral for the debt, money is fungible and it's helpful to look at the overall picture. BCS, over time, lost its primary stamp mission and became a conglomerate soup, so, for this part, i'll focus on the years 1970 to 1976. Here's the debt to equity ratios for those years:

1970  0.31    1971  0.25    1972(Mr. Buffett appears)  0.94    1973  0.76    1974  0.84    1975  0.10    1976  0.09       

In 1972, BCS acquired See's for 25M and debt increased by 32.8M but common stocks in the float portfolio increased also by 45.4M. At that time SE was 46.4M. Up to and including 1974, debt remained high as a % of equity. It's not clear why Mr. Buffett drastically decreased leverage starting in 1975 at BCS but financial leverage was clearly part of the picture for a few years.

 

On the coverage of redemption reserves from "investments", it looks like the float liability measures are comparable but the table you use for "investments" is, on a first-level analysis, like comparing apples to oranges. On a second level, it's like comparing lemons and oranges (explanations below). The major issue is that the Brooklyn Investor site uses cash, cash equivalents and fixed income for 'investments' and your table uses a different definition (same + preferred and common stocks). Here are the adjusted ratios with common stocks removed from the BCS total (preferred stocks included) "investments":

1970  0.98    1971  0.97    1972  0.68    1973  0.42    1974  0.40    1975  0.07    1976  0.35

Some comments. Bonds decreased in 1972 and disappeared after. 1975 appears anomalous as the total float decreased significantly but liquid investments decreased a similar absolute amount as common stocks and financial leverage decreased concomitantly. The most important message is that the coverage of liquid investments and fixed-income-type over float decreased significantly during those reported harem years. There are two factors that help to mitigate some of the decrease in "coverage". First, in those years the common stock portfolio was not exactly composed of nifty-fifty-like holdings; it was a group of "safe" stocks. However, the holdings had equity-like characteristics and it showed, at least temporarily, during the 1973-4 downturn. Second, as you mention, the redemption liabilities, over time, became detached from economic reality so a 1:1 coverage was certainly not essential as future developments eventually showed that the redemption liabilities had been adjusted perhaps too slow, giving rise to some IRS questions and to BRK leaders to dragging their feet for as long as possible. Anyways, during those years, i think it's reasonable to say that the float assets were heavily exposed to stocks. As time goes on, the cash flows become difficult to differentiate as See's was growing significantly but an argument could be made that, BCS, as an investment vehicle originating with significant float, was still a driving force behind the growing Wesco investments etc.

 

In addition to historical interest, what's the point? The point is that BRK has become big and the Fort Knox doctrine is in place so financial leverage is unlikely to become speculative but, given the right assets (ie utility, infrastructure-related), leverage could be part of the picture. The other point is that all this cash and short-term fixed income $ may not be all "worthless" and, given the right circumstances, may hold significant optionality.

---

Useless macro addition. Just skip.

Japan is sort of a leading light along this low or negative interest rate path. For some time, they've (the central bank) been using a negative rate for some of the cash that the banks park centrally, with the idea to "force" money in circulation for productive purposes, with a euphemistically limited success. With Covid, somebody in the ivory tower recently came up with the idea to pay banks a certain rate in order to encourage lending. The amounts happen to cancel each other. i'm just a noob but it appears to me that the net result should be neutral. No? Well no, after this new creative measure, loan growth has never seen such a rise since 2001 and this is occurring during a massive contraction. Amazing?

https://www.reuters.com/article/us-japan-money-boj/boj-paying-banks-to-boost-pandemic-relief-compensates-for-negative-interest-rates-idUSKCN2590SM

Anyways, i don' remember seeing Mr. Buffett agitated but he appears to be suppressing a level of excitement that he last openly showed when he made the harem remark:

---

[UK]

Very interesting discussions. Thank you all!

[ValueMaven]

https://omaha.com/business/local/omaha-s-megabillionaire-down-the-street-warren-buffett-set-to-celebrate-his-90th-birthday/article_52ccc925-378c-5094-8a1f-b57b3d3fb8bc.html

[Munger_Disciple]

On the coverage of redemption reserves from "investments", it looks like the float liability measures are comparable but the table you use for "investments" is, on a first-level analysis, like comparing apples to oranges. On a second level, it's like comparing lemons and oranges (explanations below). The major issue is that the Brooklyn Investor site uses cash, cash equivalents and fixed income for 'investments' and your table uses a different definition (same + preferred and common stocks). Here are the adjusted ratios with common stocks removed from the BCS total (preferred stocks included) "investments":

1970  0.98    1971  0.97    1972  0.68    1973  0.42    1974  0.40    1975  0.07    1976  0.35

Some comments. Bonds decreased in 1972 and disappeared after. 1975 appears anomalous as the total float decreased significantly but liquid investments decreased a similar absolute amount as common stocks and financial leverage decreased concomitantly. The most important message is that the coverage of liquid investments and fixed-income-type over float decreased significantly during those reported harem years. There are two factors that help to mitigate some of the decrease in "coverage". First, in those years the common stock portfolio was not exactly composed of nifty-fifty-like holdings; it was a group of "safe" stocks. However, the holdings had equity-like characteristics and it showed, at least temporarily, during the 1973-4 downturn. Second, as you mention, the redemption liabilities, over time, became detached from economic reality so a 1:1 coverage was certainly not essential as future developments eventually showed that the redemption liabilities had been adjusted perhaps too slow, giving rise to some IRS questions and to BRK leaders to dragging their feet for as long as possible. Anyways, during those years, i think it's reasonable to say that the float assets were heavily exposed to stocks. As time goes on, the cash flows become difficult to differentiate as See's was growing significantly but an argument could be made that, BCS, as an investment vehicle originating with significant float, was still a driving force behind the growing Wesco investments etc.

 

Great post CB. I didn't look closely at "Investments" held by BSC in the 70s until your post. You are 100% correct that most of BSC's "Investments" were common and preferred stocks and are not comparable to cash and very short term treasuries held by Berkshire today. Your finding actually makes me more optimistic that Berkshire will use its large cash holdings to buy a really attractive business in the future (if they find one).

[wabuffo]

You are 100% correct that most of the "Investments" are common and preferred stocks and are not comparable to cash and very short term treasuries held by Berkshire today. Your finding actually makes me more optimistic that Berkshire will use its large cash holdings to buy a really attractive business in the future (if they find one).

 

This is fun.  Let's dig deeper, ok? 

 

Once again - I have to express a debt of gratitude to the curator of the website that provided us with all of the Blue Chip Stamps annual reports -- complete with financials, and 10-Ks which give us even more detail (like the portfolio holdings of BCS).

 

But first - a mea culpa.  I made a boo-boo in my earlier table of investment assets vs trading stamp liabilities.  Starting around 1975, BCS started breaking out its short-term investments separately on its balance sheet.  I didn't pick this up until CB's comments forced me to go into the 10-Ks in order to analyze the portfolio mix.  So I've updated the table from my earlier post and added debt/equity columns as well.  It's helpful when my error actually boosts investment asset coverage  8). 

 

Here's the table and then I will make some comments.  [don't forget to click on the images for full-size viewing]

1) Starting in 1975 the investment assets have increased vs the previous table I posted because I've added the short-term cash equivalents (but not cash - I continue to exclude that).

2) Somewhere during 1972, Buffett takes over the investments and together with Munger they buy Sees for BCS.  You can see from the table, I've added the debt/equity ratios.  When Buffett/Munger purchased Sees, they used the pseudo-equity of the stamp liabilities, to borrow the money to buy Sees.  Debt-to-equity jumps from 25% to 94% during 1972 as they add over $30m in debt for the acquisition.

3) I've circled the years 1975 and 1978 because I believe they are key transition points for BCS.  After Buffett takes over the investments and they buy Sees, during 1974-75 they take advantage of the overcapitalization of BCS (sitting at 170% investment assets to trading stamp liability) to liquidate some of their portfolio and pay down debt.  At this point, we'll go take a look at the portfolio composition and detailed holdings because there is a better match between investment assets and stamp liability.

4) The reason I've also circled 1978 is because it becomes obvious that by this point, the old BCS is no more.  Buffett/Munger fully consolidate Sees and Wesco onto the balance sheet.  The investment portfolio I'm including is from the BCS 10-K, but the total portfolio is much, much larger.  For example, while my table lists $67.5m of investment assets, the consolidated balance sheet holds $134m in investment assets.  I feel that at this point, not only does BCS have more assets that it can deploy, but its liabilities are way overstated and Buffett/Munger know it (and are just trying to drag their feet on paying Uncle Sam the deferred taxes they owe).

 

So let's go take a deeper dive on BCS's portfolio mix and portfolio:

Buffett takes over sometime in 1972 and what decisions does he make about the portfolio? He clearly liquidates all the fixed income assets right away and over time the preferred stocks.  BCS always had a part of the portfolio in common equity, but Buffett increases the mix from 25% to 75% over a few years, while still keeping 20-25% in cash equivalents like time deposits, commercial paper.

 

Buffett knows that inflation is making the fixed income investments losers in real-terms.  He's written extensively about his outlook during this period.  But I would argue that his equity portfolio isn't what you typically associate with Buffett. In fact, let's take a look at the 1975 common equity portfolio (which upthread we highlighted as one of our two transition years). 

 

 

Yes - he moves into equities, but these are plain vanilla stocks that he views as safe (and a better hedge against inflation than bonds).  There's no Washington Post or GEICO in this portfolio like he's buying for Berkshire Hathaway during these years.

 

Now perhaps, we'll have to agree to disagree on this point - but I maintain that the portfolio construction is still 100% for the purposes of meeting possible liabilities.  My view is that he treats the portfolio akin to a defined benefit pension plan.  So I hold to my conclusions:

1) Buffett holds basically 100% safe assets against a float-like liability.

2) He uses the float as pseudo-equity and employs borrowed money to buy the assets and grow the equity over time (rather than deploying the investment assets).

 

Oh - I forgot, let's look at the BCS common stock portfolio for 1978:

The overall portfolio is a little smaller but many of the same utility and financial stocks are still there.  The only stocks that I would call "Buffett" stocks (which are new and also appear in BRK's portfolio starting 1980) are Cleveland-Cliffs and Pinkerton's.  Now at this point, the remaining "plain vanilla" common stocks are worth $33m (plus another $14m in S-T investments) vs $66m of stamp liability.  Does this mean that Buffett is getting more aggressive about deploying the "float"? Does it mean he knows that the stamp liability is way overstated at $66m when annual revenues are down to $16m and falling fast?  Or is it simply that the BCS is a bigger collection of businesses with significant assets and equity over and above the stamp business by this time in its evolution?

 

In the end, I believe its all of the above.  By the late 1970s, Buffett has made his mind up that he's going to consolidate everything (BCS, Diversified Retailing) into the mother ship (if only because he promised the SEC he was going to clean everything up after his legal near miss).  So I don't think 1978 tells us much because of the changes in BCS and BRK.  But the period from 1972-1975 tells us a lot.

 

Its all fun stuff and really neat for financial history nerds like myself.  However, my thesis stands.  I still maintain that this is an a-ha moment that I will use in my approach to valuing Berkshire Hathaway.

 

wabuffo

[RadMan24]

https://omaha.com/business/local/omaha-s-megabillionaire-down-the-street-warren-buffett-set-to-celebrate-his-90th-birthday/article_52ccc925-378c-5094-8a1f-b57b3d3fb8bc.html

 

That was a good read, thanks for that ValueMaven.

[Munger_Disciple]

BCS always had a part of the portfolio in common equity, but Buffett increases the mix from 25% to 75% over a few years, while still keeping 20-25% in cash equivalents like time deposits, commercial paper.

 

Buffett knows that inflation is making the fixed income investments losers in real-terms.  He's written extensively about his outlook during this period.  But I would argue that his equity portfolio isn't what you typically associate with Buffett. In fact, let's take a look at the 1975 common equity portfolio (which upthread we highlighted as one of our two transition years). 

....

 

Yes - he moves into equities, but these are plain vanilla stocks that he views as safe (and a better hedge against inflation than bonds).  There's no Washington Post or GEICO in this portfolio like he's buying for Berkshire Hathaway during these years.

 

Now perhaps, we'll have to agree to disagree on this point - but I maintain that the portfolio construction is still 100% for the purposes of meeting possible liabilities.  My view is that he treats the portfolio akin to a defined benefit pension plan.  So I hold to my conclusions:

1) Buffett holds basically 100% safe assets against a float-like liability.

2) He uses the float as pseudo-equity and employs borrowed money to buy the assets and grow the equity over time (rather than deploying the investment assets).

....

 

Its all fun stuff and really neat for financial history nerds like myself.  However, my thesis stands.  I still maintain that this is an a-ha moment that I will use in my approach to valuing Berkshire Hathaway.

 

wabuffo

 

Thanks for the detailed response wabuffo. It is clear that Buffett moved most of BCS's portfolio to common stocks after he took over. We also know (now) that inflation was raging in the 70s. One side effect of it was rapid erosion of the real value of stamp liabilities so it is possible that Buffett was more aggressive on the asset side by moving capital to "safer" common stocks in addition to selling fixed income instruments. Obviously we don't know for sure what was on Buffett's mind at that time, but it is a reasonable guess. Still common stocks were much more volatile than cash/short term bonds and it is hard to argue that Buffett was covering 100% of the liabilities with "safe" assets.

 

We also have Buffett on record repeatedly saying he needs to keep only $20B cash on hand for covering insurance needs and he could use the rest for acquisitions/investments. Though I agree that Buffett's actions during the last decade seem to belie this.

 

In any case the current interest rate environment is almost diametrically opposite to that of the 70s though it could change at any moment without warning. Perhaps this is the reason Buffett has been covering 100% of insurance float with cash + ST treasuries for the last 10 years. 

 

-MD

 

 

 

[Cigarbutt]

This is fun... 

Now perhaps, we'll have to agree to disagree on this point - but I maintain that the portfolio construction is still 100% for the purposes of meeting possible liabilities.

...

wabuffo

This exchange (my perspective anyways) was very useful and this has become mostly a half-empty or half-full kind of residual question. Thanks.

 

-Historical part

The BCS float portfolio's main goal was to match redemption liabilities. The idea is to be in a situation to be able to hold the security (bond or equity) to maturity or for a long time. The equities held had a different risk-return profile (less risk and less return) but the overall float portfolio was a significant contributor to the recurrent annual investment income line and (it seems to me) Mr. Buffett waited (he had the flexibility to do so) until markets recovered after the 73-4 downturn before selling excess float stocks. It became clear then that the redemption liability was on its way to oblivion and those associated (100% association if you insist on that notion) float stocks had their future defined. i would submit that many people don't fully appreciate the genius investment (and the way the transition was handled) that BCS was, despite being literally a target of various lawsuits and dying business model.

 

-Contemporary part

If you were responsible for the 100% liability portfolio at BRK now, how would you deal with capital allocation? (would you allocate a portion to gold?  :) ) i wonder if one could imagine a float portfolio composed of a significant amount of regulated return equity positions (energy, utility, infrastructure) bought at reasonable prices in exchange for worthless cash, with the intention to hold forever, with the value of the regulated entities growing with the insurance float. Some kind of permanent virtuous circle, of lasting legacy. After all, BRK started out as a textile mill operation.

[Libs]

<We also have Buffett on record repeatedly saying he needs to keep only $20B cash on hand for covering insurance needs and he could use the rest for acquisitions/investments. Though I agree that Buffett's actions during the last decade seem to belie this.>

 

Exactly.

 

So why would Buffett be so disingenuous about such a huge issue? He's been saying one thing ( "we have all this spare cash and I'm frustrated we can't find anything") and doing another ( managing the portfolio to match liabilities) for a VERY long time. What's the upside to this - dare I say - deception?

 

He's not the type to do this to string along investors ( by implying the next elephant is around the corner).

 

I'm baffled.

[bizaro86]

<We also have Buffett on record repeatedly saying he needs to keep only $20B cash on hand for covering insurance needs and he could use the rest for acquisitions/investments. Though I agree that Buffett's actions during the last decade seem to belie this.>

 

Exactly.

 

So why would Buffett be so disingenuous about such a huge issue? He's been saying one thing ( "we have all this spare cash and I'm frustrated we can't find anything") and doing another ( managing the portfolio to match liabilities) for a VERY long time. What's the upside to this - dare I say - deception?

 

He's not the type to do this to string along investors ( by implying the next elephant is around the corner).

 

I'm baffled.

 

I wonder if those statements are targeted toward insurance regulators. If they say in a filing they think they only need $X in capital it would be a bad look for him to say they need 5X in public.

 

Just speculating.

[Guest longinvestor]

<We also have Buffett on record repeatedly saying he needs to keep only $20B cash on hand for covering insurance needs and he could use the rest for acquisitions/investments. Though I agree that Buffett's actions during the last decade seem to belie this.>

 

Exactly.

 

So why would Buffett be so disingenuous about such a huge issue? He's been saying one thing ( "we have all this spare cash and I'm frustrated we can't find anything") and doing another ( managing the portfolio to match liabilities) for a VERY long time. What's the upside to this - dare I say - deception?

 

He's not the type to do this to string along investors ( by implying the next elephant is around the corner).

 

I'm baffled.

 

I wonder if those statements are targeted toward insurance regulators. If they say in a filing they think they only need $X in capital it would be a bad look for him to say they need 5X in public.

 

Just speculating.

 

Regulators worry about minimum capital, no? After that’s where most insurers are.

 

Another one of the awkwardness of being rich. They’re not going to highlight that.