Archive for 'Warren Buffett'

Warren Buffett, the man, the legend, is now 87 years old, has some history with cancer and is well aware that his best days are behind him. Rumors are flying that he’s been negotiating with God himself to continue running Berkshire from the grave-at least that’s the word on the street but I can’t verify that.  I suspect that the real plans involve mere mortals.

Warren Buffett is deservedly known as the greatest investor of all time. His track record with Berkshire Hathaway (BRK.B) (BRK.A) is remarkable. And yet, for investors, that track record isn’t necessarily enough to justify purchasing the stock. As everyone who has ever looked at a mutual fund knows, past performance is no guarantee of future results. As Buffett himself put it a bit more cheekily:

That may seem easy to do when one looks through an always-clean, rear-view mirror. Unfortunately, however, it’s the windshield through which investors must peer, and that glass is invariably fogged

Source: The Snowball, by Alice Schroeder

Why Would the Market Pay Extra for Buffett?

When trying to determine whether the value of the company (and thus the stock price) will drop after the death of Mr Buffett, it is worth inverting (as his partner Charlie Munger always says). The question then becomes, why is the market paying up for him to be running things.

Let’s think about the sources of value inside Berkshire Hathaway. There are insurance operations which earn money year in and year out on underwriting. He doesn’t do the underwriting but has created a great corporate culture. Probably Ajit Jain and Co. are adding the value here. The company has wholly owned subsidiaries in the utility, railroad, industrial, consumer product, financial, and media spaces. Given the size of the company, he isn’t actively running any of these businesses. There may be a bit of a halo effect, but I doubt it moves the needle. The final sources of value are investments and cash. Some of the investment have appreciated so much that it would be tough to sell them due to taxes owing (I’m looking at you Coca-Cola (NYSE:KO)), but new investments of cash are definitely the place where Buffett adds the most value.

More broadly, his value add is in capital allocation, which is basically the art of determining what to do with cash. He is objectively superior at that, which increases the likelihood of the company’s cash balances (and future cash income streams) being invested to earn a high return. That increases the present value of that cash to investors, and I believe is the primary source of any “Buffett premium.”

As someone who frequently writes on and invests in microcap net-nets, I am deeply aware that the market does not always value a dollar of cash at a dollar of market capitalisation. In Berkshire’s case, the huge cash pile is likely valued at a least a dollar for every dollar, because the market believes Warren Buffett will use the money effectively, as well as effectively allocate the significant cash flow that the business throws off each and every year.

Some of that Buffett premium is likely to disappear when Buffett passes away, and that day is inevitably getting closer. With Buffett now 87 and having had prostate cancer, he is certainly much closer to the end of his investing career than the beginning. Berkshire had the following to say about the matter in the Risks section of its most recent 10-k.

We are dependent on a few key people for our major investment and capital allocation decisions.

Major investment decisions and all major capital allocation decisions are made by Warren E. Buffett, Chairman of the Board of Directors and CEO, age 86, in consultation with Charles T. Munger, Vice Chairman of the Board of Directors, age 93. If for any reason the services of our key personnel, particularly Mr. Buffett, were to become unavailable, there could be a material adverse effect on our operations. However, Berkshire’s Board of Directors has identified certain current Berkshire subsidiary managers who, in their judgement, are capable of succeeding Mr. Buffett. Berkshire’s Board has agreed on a replacement for Mr. Buffett should a replacement be needed currently. The Board continually monitors this risk and could alter its current view regarding a replacement for Mr. Buffett in the future. We believe that the Board’s succession plan, together with the outstanding managers running our numerous and highly diversified operating units helps to mitigate this risk.

 

It has called out its succession plan as a mitigating factor to this risk, and when Buffett dies, I believe the successor(s) will be announced very shortly thereafter. However, there is one other big reason I am not very concerned about Mr Buffett’s eventual death, and that is I believe that capital allocation is actually getting easier at Berkshire Hathaway for a number of important reasons.

Reinvestment in Berkshire’s Owned Businesses

The simple fact is that he has, over the last 15 or so years, designed Berkshire to be able to reinvest a material portion of its excess capital internally. Capital-heavy acquisitions like Burlington Northern and its utility subsidiaries have a continual need for more capital and are a great way to reinvest the capital that comes from the other businesses and portfolio dividends without needing to make as many acquisitions.

The utility businesses especially are a great place to put new capital, because new capital investment in regulated utilities earns a regulated return. Thus, Buffett’s successor has a home from money that will earn a guaranteed rate of return that is generally around the cost of equity, or high single digits to low double digits. That will help take the pressure off.

The other thing that will help is that Berkshire has been acquiring companies that themselves grow by acquisition. The utility subsidiaries are the biggest example of this group, but there are a number of others. As a couple of examples, the Marmon group of companies regularly makes acquisitions, and Berkshire purchased Precision Castparts for a relatively full price, partially paying for its ability to grow its earnings using Berkshire’s capital. These (and many other) subsidiaries making tuck-in acquisitions will help Buffett’s successor effectively allocate capital by reducing the amount of money they need to allocate.

How Berkshire’s Buyback Plan Helps Allocate Capital

I believe the company’s buyback plan is also built to help Buffett’s successor allocate capital. If Berkshire’s stock falls on Buffett’s death and goes below the board’s buyback floor, the successor will have an easy way to accretively use Berkshire’s capital. There would be no reasonable way for anyone to criticise buying back Berkshire stock at a level previously endorsed by Warren Buffett himself.

 

The successor (and board) could also begin paying a dividend, although I think that is less likely. While a dividend has the attraction of being able to use an unlimited amount of capital in an intelligent way, it is also (at least indirectly) an admission by the successor of not being as savvy a capital allocator as Mr Buffett. Now, that is an admission that basically anyone should be happy to make, but for market confidence reasons, I can see why the board may not want to do so.

See more on Warren Buffett

 

 

 

Apple Stock to Double in Value?

Is it possible that a company as famous and as successful as Apple could be undervalued by roughly 100%. Are all the Stock Market Guru’s and financial experts asleep at the wheel? I don’t know the answer to that but I do know that one pretty damn good investor, Warren Buffett, just recently purchased about 130 million shares of Apple. Maybe he knows something we don’t. 

It would seem an odd thing that the most famous company over the past decade, and today’s market cap leader, could be seriously undervalued versus related, somewhat similar investment opportunities.

The first sections run through some simple arithmetic and the underlying assumptions to show that a rational investor (yours truly, I hope) can easily justify $300+ right now for AAPL shares for new money looking at related alternative homes for the money. The second part of the article provides my take on how and why this intensely-studied company with a narrow product line could end up being so undervalued, and why Mr. Market is wrong here.

I use Warren Buffett’s somewhat recent large stake in AAPL and comments he made more than once on the stock this year to discuss what I think that he, as an example of the mythical Mr. Market, gets right about the stock and what Mr. Market may still be getting wrong. This is important to me, because if I’m bullish on an asset, I want to know why the asset is misperceived and therefore mispriced.

One small note before the meat of the article: this was written on Sunday night, with Friday’s closing prices. I was on the road and did not have time to submit this until Tuesday, pre-open. AAPL is up a little to $159.75 at this time, versus $157 when the article was written. The S&P 500 (SPY) is up marginally from Friday, as well. Please adjust for this if you want to be precise.

I doubt this is necessary, as the real point of this article is not to say that AAPL is worth some specific number, rather that if it’s reasonable to calculate that its fair value is about double its current price, it’s a strong contender to be A) owned and B) overweighted in an investment portfolio.

First, the basic math that shows the undervaluation, and the assumptions that are used to get there.

Estimating AAPL’s earnings yield

AAPL is a good stock for an earnings yield approach, because its free cash flow is similar to its EPS. That’s as opposed to companies with high capital spending needs, such as IaaS companies or oil producers.

The earnings yield is the reciprocal of the P/E, expressed as a percentage. So, a 20X forward P/E would translate to a 1/20 = 5% forward one-year earnings yield.

What is AAPL’s forward earnings yield? Of course, we don’t know the future, but AAPL has enough stability that allows a guess to be made (that’s my first assumption). Just going with consensus, which shows $11.05 as FY 2018’s EPS, and at Friday’s close for AAPL around $157, the following earnings yield can be projected in a way that makes AAPL comparable to most of its large cap peers.

Namely, AAPL has so much extra cash and a high profit, high-FCF business model that it could lever up a bit and then have a balance sheet much more like its peers in SPY. Except for a small number of other tech giants, AAPL’s other comparators in SPY or Dow 30 (DIA) and general large cap sector have already levered up. So I first subtract about $14/share of value from AAPL’s stock price.

This $14 number is computed using AAPL’s 6/30/17 balance sheet that shows the following assets that are cash-like or otherwise liquid:

  • $77 B in cash and short-term investments
  • $23 B in receivables
  • $10 B in other current assets
  • $185 B in long-term investments

These total $294.5 B including rounding.

From this, I subtract all liabilities, which total $213 B.

This leaves $81.8 B of excess financial assets, or close to $16/share. When thinking about the availability of this to shareholders via either dividends or share buybacks, tax must be paid first, so I haircut this to $13/share. That leads to an adjusted share price of $144, or 13X consensus forward EPS. That comes to a 7.7% earnings yield, which is likely to be similar to AAPL’s FCF yield.

There are at least two small adjustments to think about regarding that earnings yield. One is that without all those balance sheet assets, AAPL would earn a little less in interest income. The other is that to simplify thinking about forward earnings with those of peers such as Alphabet (NASDAQ:GOOG) (GOOGL) and Amazon (AMZN), it’s reasonable to think of CY 2018, not AAPL’s FY 2018 that ends at the end of September next year.

There is a larger potential adjustment, namely that the trend of consensus FY 2018 EPS estimates has been moving up. Over many years of AAPL-watching, that trend has been the investor’s friend, and I expect the same this fiscal year as well.

So I’m going to go with a forward adjusted earnings yield of 8% for AAPL based on CY 2018 EPS. It’s approximate, but good enough to use for further analysis.

The next section contains some comparisons of AAPL stock with alternatives. I’m using a 10-year time frame, assuming that major companies and major investments are best thought of that way rather than worrying about what happens this quarter or this year. It is going to take many years for a share of any stock to pay off in reality (as opposed to trading it for capital gains).

The assumptions

The assumptions are twfold.

One relates to the market as a whole:

According to a spreadsheet that Standard and Poor’s maintains, S&P 500 GAAP EPS have risen at a 5.5% annual rate since the calendar year ending 12/31/88. This assumes $107 EPS for the S&P 500 (SPY) for Q3, for which earnings are just now being reported.

I’m going to assume that 5.5% remains the CAGR for EPS of SPY for the decade ahead.

The next assumption is that AAPL will beat SPY by about 2.5% per year, i.e. grow EPS at an 8% CAGR over the next 10 years, due to its leading positions in the tech sector and in the consumer products sector. AAPL products are changing the world more than those of any other company, and the change is just getting going (think Apple Watch and Apple Pay along with the iPhone).

AAPL as an absolutely undervalued stock (not a comparison)

Basic math: If AAPL’s 1-year forward earnings yield is 8%, and EPS compound at 8% per year, then AAPL’s share price will rise to $192 by year 10 if AAPL’s earnings yield (P/E) in 10 years remains the same as it is now.

This would be more than OK from a zero coupon bond or a junior biotech, but in addition, shareholder returns include the actual earnings that AAPL will be making over the 10 years and which it will either retain or deliver to shareholders via dividends and/or buybacks. Since we do not know the precise path of the assumed 8% growth rate (it’s unlikely to be steady as compound interest is), I assume 10% per year as a conservative average annual total return, probably more like 11% if the growth path is relatively steady or (better) front-loaded.

Thus, total returns in this situation would be in the range of 8% price appreciation just from EPS growth, plus an average of 10% or more earned and returnable to shareholders along the way each year. This implies a high-teens annual total return if the terminal P/E stays the same.

This is clearly “too high.” the question is, what is an appropriate forward earnings yield?

My answer is 4%, which would provide a 7.7% yield in year 10 at 8% compounded annually. The average yield is around 5.5%, which is similar to the yield on many junk bonds. I would rather have AAPL, but the comparison is not easy.

This implies a TTM P/E for AAPL right now around 35X, similar to that of Facebook (FB) and Alphabet, and an AAPL price around $300 per share.

A 4% forward earnings yield right now also implies that at the end of year 10, investors would be looking at a forward earnings yield of 8.3% at an unchanged stock price and the same 8% growth rate. So, the predictable return in this case would be the actual earnings. The unpredictable part would be whether AAPL’s price would be higher than $157, giving a lower forward earnings yield, or lower than that, trading at a higher forward earnings yield.

I would think this is a fair choice, and that AAPL’s forward earnings yield of 4% “works” by this general analysis. Even requiring a 5-6% as a starting earnings yield would mandate a sharp repricing of AAPL much higher right now to get to that fair value.

 

More on Apple Stock

U.S. General Public Gives Corporate America’s Most Visible Companies Higher Ratings Overall; Largest Number of Individual Companies Rank ‘Excellent’ in 12-year History of RQ Study

After falling to unforeseen lows amidst scandals, recalls and self-inflicted demonization economic crises, the American public’s positive perception of the reputation of corporate America is on the rise. Overall corporate reputation is experiencing rehabilitation as the American public gives high marks overall to corporate America, specific industries, and the largest number of individual companies in a dozen years. This, according to the findings of the 2011 Harris Interactive RQ Study, which measures the reputations of the 60 Most Visible Companies in the U.S.  This is the 12th year for the study, established in 1999.

To view the multimedia assets associated with this release, please click: http://multivu.prnewswire.com/mnr/harrisinteractive/44749/

Of the 20 notable changes in reputation among the 54 companies measured in both 2010 and 2011, 18 had significant positive increases, compared to only two declines. An astounding 16 companies received an RQ score over 80, which is considered to be an “Excellent” reputation, a sharp increase from the six companies so recognized in the 2010 survey.

Google ranked highest, supplanting Berkshire Hathaway, which falls to the 4th position. Johnson & Johnson ranked second again, followed by 3M Company at 3rd. Apple continues a steady rise begun in 2002, ranking 5th, as its corporate reputation catches up with its elite brand status.

Robert Fronk, Senior Vice President, Global Practice Lead, Reputation Management at Harris Interactive, stated, “The record 16 companies that received RQ scores reflective of an excellent reputation should all be lauded for their focus and commitment to reputation management. These companies recognize that it is this behavioral commitment that earns them reputation equity, not tactics designed to help them score well on lists like these.”

Google Vice President of Consumer Marketing Gary Briggs reacted to the news. “We have always believed that if we focus on making the best products for our users all else will follow. We’re honored to be recognized in this ranking and we will continue to put our users first.”

Tech Looms Large

The technology sector continues to be perceived most positively, with 75% giving the sector a positive rating, versus the number two sector, retail, which fares at 57% positive. Technology/Internet and Consumer Goods companies dominate the top rankings, with top 10 finishers 3M, Apple, and amazon.com benefitting from being associated with both industries.

“These top-scoring companies are seen as supporting the infrastructure of the lives of the American public,” says Robert Fronk, “and they get credit for simplifying, delighting, or enriching people’s lives.”

Facebook is a newcomer to the RQ Most Visible List, debuting in the middle of the pack (ranked 31st) with a RQ score of 74.12.

Auto Industry Shines

The auto industry had a significant increase in positive perceptions, jumping 15 points from 2010, the largest year-over-year gain by any industry in the study’s 12-year history.

All three domestic auto companies demonstrate positive momentum compared to 2010 and were among the ten most improved companies in the study. Building on its progress from last year, Ford improved its RQ score to 74.61, from 69.77. Ford is the second highest ranked car company, following Honda, which maintained its consistently high rating. Toyota ranks third among automakers but suffered a RQ decline of 9.96 points. GM and Chrysler achieved the 3rd and 4th highest gains in 2011.

Stabilizing but Still Struggling

Financial services firms and oil companies continue to populate the bottom of the rankings. AIG came in last position, with newcomer BP just edging above in the 59th position.  Goldman Sachs and Citigroup filled the remaining 2 slots in the bottom four. These four lowest rated companies were also rated lowest on the reputation characteristics of “being trusted to do the right thing” and “having high ethical standards”.

Following are some additional findings of interest:

  • The top 10 companies on this year’s list in order of ranking include: 1) Google; 2) Johnson & Johnson; 3) 3M Company; 4) Berkshire Hathaway; 5) Apple; 6) Intel Corporation; 7) Kraft Foods; 8) amazon.com; 9) General Mills; 10) The Walt Disney Company.  For a full list of the top 60 companies and other findings visit: www.harrisinteractive.com.
  • In addition to the top 10, 6 other companies received scores indicating they have an excellent reputation level. Those additional companies are: Proctor and Gamble Co., SC Johnson, UPS, Sony, The Coca-Cola Company, and Microsoft.
  • The bottom 10 companies on this year’s list in order of ranking include: 51.) Delta Airlines; 52) JP Morgan Chase; 53) Exxon Mobil; 54) General Motors; 55) Bank of America; 56) Chrysler; 57) Citigroup; 58) Goldman Sachs; 59) BP; 60) AIG.
  • There are six reputational dimensions that the RQ survey focuses on that influence reputation and consumer behavior. Below are the six dimensions along with the five corporations that ranked highest within each:
    • Social Responsibility – 1) Whole Foods Market; 2) Johnson & Johnson; 3) Google; 4) The Walt Disney Company; 5) Procter & Gamble Co.
    • Emotional Appeal – 1) Johnson & Johnson; 2) amazon.com; 3) UPS; 4) General Mills; 5) Kraft Foods
    • Financial Performance – 1) Google; 2) Berkshire Hathaway; 3) Apple; 4) Intel; 5) The Walt Disney Company
    • Products & Services – 1) Intel Corporation; 2) 3M Company; 3) Johnson & Johnson; 4) Google; 5) Procter & Gamble Co.
    • Vision & Leadership – 1) Berkshire Hathaway; 2) Google; 3) Apple; 4) Intel Corporation; 5) The Walt Disney Company
    • Workplace Environment – 1) Google; 2) Johnson & Johnson; 3) Apple; 4) Berkshire Hathaway; 5) 3M Company

Additional Information

To review selected research from the 2011 Harris Interactive RQ survey, please visit www.harrisinteractive.com.

Reputation Quotient Methodology

In its 12th consecutive year, The Annual RQ surveys more than 30,000 members of the American general public, utilizing its proprietary Harris Poll online panel. Respondents are first asked to identify the 60 most visible companies and then surveyed to rate these companies based on their reputation on 20 different attributes that comprise the RQ instrument.  The attributes are then grouped into six different reputation dimensions: Emotional Appeal, Products & Services, Social Responsibility, Vision & Leadership, Workplace Environment, and Financial Performance. In addition to the 20 attributes, the study includes a number of reputation-related questions that help provide a comprehensive understanding of public perceptions.  The 2011 RQ survey was conducted from December 30, 2010 to February 22, 2011.

About Harris Interactive

Harris Interactive is one of the world’s leading custom market research firms, leveraging research, technology, and business acumen to transform relevant insight into actionable foresight. Known widely for the Harris Poll and for pioneering innovative research methodologies, Harris offers expertise in a wide range of industries including healthcare, technology, public affairs, energy, telecommunications, financial services, insurance, media, retail, restaurant, and consumer package goods. Serving clients in over 215 countries and territories through our North American, European, and Asian offices and a network of independent market research firms, Harris specializes in delivering research solutions that help us – and our clients – stay ahead of what’s next. For more information, please visit www.harrisinteractive.com.

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