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Nygren's latest letter


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If you had asked any investor in 2007 how their bank stocks would fare if real estate prices fell by 30%, I doubt that even one of them would have said, "I think they’d be fine." Our big mistake was that we didn't see the real estate crash coming. 

http://www.oakmark.com/Commentary/Commentary-Archives/2Q14--Bill-Nygren.htm?rf=dr

 

 

Personally, I don't think that was his mistake.

 

Warren Buffett's financial picks survived just fine.

 

Nygren chose Washington Mutual to concentrate in, and Buffett was concentrated in Wells Fargo.

 

So was not forecasting the real estate decline really Nygren's mistake?

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Agreed, there was more to that.

 

It was the largest holding at 15%.

 

And he did not recognize the issue until it was too late.

 

Dec 2007

It would be cathartic to just sell WaMu now. However, I continue to believe the stock has a very attractive risk-return profile. WaMu's deposit franchise remains strong, and I find it highly unlikely that potential loan losses will overwhelm the company’s franchise value. Whenever we own a stock that declines sharply we ask ourselves the question: if we didn’t already own this would we buy it now? I’m confident that the answer for WaMu is a resounding “yes.”

 

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If you had asked any investor in 2007 how their bank stocks would fare if real estate prices fell by 30%, I doubt that even one of them would have said, "I think they’d be fine." Our big mistake was that we didn't see the real estate crash coming. 

http://www.oakmark.com/Commentary/Commentary-Archives/2Q14--Bill-Nygren.htm?rf=dr

 

 

Personally, I don't think that was his mistake.

 

Warren Buffett's financial picks survived just fine.

 

Nygren chose Washington Mutual to concentrate in, and Buffett was concentrated in Wells Fargo.

 

So was not forecasting the real estate decline really Nygren's mistake?

 

I agree. 90% of money managers did not foresee the housing bubble, but many survived by not exposing themselves to the worst of the housing dependent stocks.

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If you had asked any investor in 2007 how their bank stocks would fare if real estate prices fell by 30%, I doubt that even one of them would have said, "I think they’d be fine." Our big mistake was that we didn't see the real estate crash coming. 

http://www.oakmark.com/Commentary/Commentary-Archives/2Q14--Bill-Nygren.htm?rf=dr

 

 

Personally, I don't think that was his mistake.

 

Warren Buffett's financial picks survived just fine.

 

Nygren chose Washington Mutual to concentrate in, and Buffett was concentrated in Wells Fargo.

 

So was not forecasting the real estate decline really Nygren's mistake?

 

I agree. 90% of money managers did not foresee the housing bubble, but many survived by not exposing themselves to the worst of the housing dependent stocks.

 

In other words, you wear a seatbelt not because you forecast an accident, but because you really don't know what will happen.

 

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"That brings me to our newest position, which will no doubt make some question our credentials as value investors: Amazon.

 

Consensus forward earnings for Amazon are a little over a dollar. At the median forward P/E multiple, Amazon would be priced in the low $20s. So, even though the stock fell $124 from its January high of $408 to a May low of $284, its P/E ratio remained in nosebleed territory. But we have never believed the P/E ratio was the be-all and end-all for valuation. Amazon is a retailer – a very efficient retailer. When we compare stocks in the same industry, we often compare their market caps to their sales rather than their earnings.  Since 2001, Amazon has generally traded at a cap-to-sales ratio of two to four times that of the average bricks-and-mortar retailer.  Having fallen to just under two recently, one might say that, as an advantaged retailer, Amazon looks somewhat attractive.

 

But that metric misses an important change in Amazon’s business.  Third-party sales (sales on amazon.com where the seller is not Amazon) have grown more rapidly than Amazon’s direct business.  And on those transactions, accounting rules credit only Amazon's commission as revenue.  So if you buy a $100 item on amazon.com from a third party, Amazon is only allowed to show about $13 of revenue, nearly all of which is gross profit.  For third-party sales, Amazon is effectively functioning as the mall owner, collecting a percentage of sales as rent.  Amazon earns less gross profit on that sale than an average retailer would, but it is also a much lower risk endeavor.  For that reason, we think a dollar of third-party sales should be worth about the same as a dollar that Amazon sells directly.

 

It gets interesting when we adjust our cap-to-sales ratio comparison to include estimated gross third-party sales.  Instead of selling at twice the ratio to sales of the average bricks–and-mortar retailer, Amazon is selling at only 80%.  So, relative to gross sales, Amazon's stock would have to increase 25% to be priced consistent with the very companies whose survival Amazon is threatening.  On that metric, Amazon has never been cheaper.

 

Should Amazon sell at a discount on sales? The answer largely rests on what Amazon could earn if it wasn’t investing so heavily for future growth.  For most asset heavy businesses, growth investment is primarily on the balance sheet, and is slowly expensed on the income statement as depreciation throughout its useful life.  In an asset–lite business like Amazon, however, most growth spending gets directly expensed to the income statement, creating a much larger immediate reduction in income.  We believe that if Amazon sharply curtailed its growth spending so that it only grew at the rate other retailers grow, it could produce similar operating margins.  But we don't want them to do that.  We believe that management is maximizing value by investing heavily for super-normal organic growth.  So, yes, Amazon is a rapidly growing business.  But at this price, we believe it is also a value stock."

 

This is what interests me, not the banking discussion.  :D

While I don't know if it is true, I am thinking to keep my AMZN stocks instead of selling them, when I receive them as an employee.  :D

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I was a holder of the Oakmark Select fund through this period when he had a huge stake in WaMu. I never felt like he owned up to the mistake in his shareholder letters both during the crisis and as things got better. In my opinion, until you fess up to your specific mistake and put in process to avoid it in the future, there is a risk you'll repeat it.

 

I don't think WaMu and Wells Fargo are equal. I think if you're going to build a 15% position in a company, you should be confident in the quality of the loan book and the culture of underwriting. Wells Fargo would have made it through the crisis without help, WaMu wouldn't have. The quality of the loans were much worse. Wells Fargo made mistakes in underwriting some products but not on the scale that WaMu did.

 

The WaMu deposit franchise and the footprint had tremendous value, but on the other side the loan book cancelled it out.

 

When I look at banks, I have to feel comfortable with the culture. As an investor we have limited information so we must look for clues. The loan book is similar to the derivative book and their culture of managing risk. You can't avoid everything, but you do have to worry about it.

 

My direct understanding of WaMu isn't great, but it's from what I read around the time it went under and was sold to Wells Fargo.

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If you had asked any investor in 2007 how their bank stocks would fare if real estate prices fell by 30%, I doubt that even one of them would have said, "I think they’d be fine." Our big mistake was that we didn't see the real estate crash coming. 

http://www.oakmark.com/Commentary/Commentary-Archives/2Q14--Bill-Nygren.htm?rf=dr

 

 

Personally, I don't think that was his mistake.

 

Warren Buffett's financial picks survived just fine.

 

Nygren chose Washington Mutual to concentrate in, and Buffett was concentrated in Wells Fargo.

 

So was not forecasting the real estate decline really Nygren's mistake?

 

I reread your initial post. I agree with you.

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Despite my extreme AMZN bullishness, I find his AMZN analysis way too simplistic.  I hope there's more to his thesis than that, although if I'm right he doesn't need more.

 

 

I'm also highly skeptical of the 'franchise' part of 'deposit franchises'.  Seems like you could actually replicate or at least build your own national deposit franchise.  This is evidenced by the fact that there ARE multiple national deposit franchises and and a plethora of regional ones.

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If you had asked any investor in 2007 how their bank stocks would fare if real estate prices fell by 30%, I doubt that even one of them would have said, "I think they’d be fine." Our big mistake was that we didn't see the real estate crash coming. 

http://www.oakmark.com/Commentary/Commentary-Archives/2Q14--Bill-Nygren.htm?rf=dr

 

 

Personally, I don't think that was his mistake.

 

Warren Buffett's financial picks survived just fine.

 

Nygren chose Washington Mutual to concentrate in, and Buffett was concentrated in Wells Fargo.

 

So was not forecasting the real estate decline really Nygren's mistake?

 

I agree. 90% of money managers did not foresee the housing bubble, but many survived by not exposing themselves to the worst of the housing dependent stocks.

 

In other words, you wear a seatbelt not because you forecast an accident, but because you really don't know what will happen.

 

Agreed. Having never read one of Nygren's letters before, I found it to be quite thoughtful and candid, though. Needless to say that I'm in complete agreement with their current thesis on banks.

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Despite my extreme AMZN bullishness, I find his AMZN analysis way too simplistic.  I hope there's more to his thesis than that, although if I'm right he doesn't need more.

 

 

I'm also highly skeptical of the 'franchise' part of 'deposit franchises'.  Seems like you could actually replicate or at least build your own national deposit franchise.  This is evidenced by the fact that there ARE multiple national deposit franchises and and a plethora of regional ones.

 

I think you might misunderstand this slightly. The question is -- could you take away a meaningful percentage of Wells' or B of A's, or JP Morgan's deposits? How are you going to do it? Why move? (Whether you're a retail depositer or an institutional one.)

 

B of A is a good example. Think of all of the awful headlines over the past five years. $60 billion+ in lawsuits, overcharging retail customers for fees, Moynihan's overstatements and retrenchments, etc. Not long ago, there was a national "campaign" of sorts to get people to leave the B of A because of overdraft fees and that kind of behavior.

 

Yet, here are the year end deposit figures (billions):

 

2009: $991

2010: $1,010

2011: $1,033

2012: $1,105

2013: $1,119

 

I think that's a franchise, in any useful way you might define it. But reasonable minds can differ.

 

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good discussion, thanks for having it.

 

coc, one obvious concern with the "deposit franchise" is what happens when interest rates eventually rise. i am concerned that the combination of: 1) the ease to ACH money around, 2) everyone having smartphones, etc. 3) national competitors at marketing/advertising scale like Capital One Direct/ING will make the stickiness/competitiveness of deposits "different this time." 

 

the first iphone was released in 2007. interest rates have been basically 0% since that time. isn't it possible that interest rates required to retain deposits are much more competitive than the past?

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Wamu not Nygren's finest hour. I think:

1. It was a safe place to hide, and 2. It would eventually be a deal(perhaps with his "help". Problem is, anyone looking at the income staement could see they were booking negative am as cash profits. That was the warning, but went unheeded. I remember Cramer talking about using the Wamu dividend as a safe harbor....ummm.really?

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  • 4 years later...

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