Berkshire Hathaway - Meeting Notes Part I

The meeting opened with the cousin Jimmy Buffett playing the Berkshirehathawayville version of his song.
WB announced his plan for a cartoon series for children to impart financial education in an enjoyable manner.
The Q1 2007 results were posted with WB explaining that insurance rates have come down recently, but the effect will start showing up in a couple of quarters or so due to a lag effect in rates ratcheting down. He offerd caution on cat. insurance and mentioned that over a long term berky would be expect to break-even in tnis business and still come ahead because of its ability to manage float and generate float income.
He brought up the issue of a high accounts receivable by 7 billion than normal due to the Equitas deal closing in April.
Views on:-
Private Equity
* Funds invested are locked in. It's hard to get out for the investor.
* Fund Managers are compelled to invest since it is in their interest to earn more fees by generating more funds. They cannot go back to investors with surplus funds in hand.
* Trigger for the slow down could be junk bond yield spreads going up higher hampering leverage.
Overseas investments
WB has no bias against. Low holdings not reported in annual report. Reporting limit threshold of 3% in Europe a deterrent.
Executive Compensation
* Ratcheting and envy at play
* Non-independent comp committees.
* Compensation should be based on controllable factors. For instance, extraction cost based comp for an oil executive, not oil prices. Factor should be relevant as well.
Interest rates
* Credit contraction as a result of higher rates.
Contraction as was historical is not probable. Fed not likely to orchestrate a credit crunch. Follies of excess liquidity may bring about unhealthy legislation.
High Corporate profits
WB - Share in GDP getting higher, labor's share down It is not likely to persist.
CM - Share of financials is higher is the causw. Investment banks etc earning abnormal profits. Historically high consumer credit is also the reason.
Naked Shorting
WB welcomes shorters, sees it as a money making opportunity by lending stocks.
It is a hard position to take.
Gambling
* Excitement seeking is the underlying.
* Tax on ignorance - making it easier to gamble is preying on ignorance, not the job of a govt that serves people.
How to become a good investor
* Read everything you can
* Fill your minds with ideas, sort out the good ones
* Jump into investing. Reading about investing and actually doing it is as different as reading a romance novel and actually doing "something else".
* WB has same thought pattern as when he was 19 abt investments
CM - Rationalise - "What do you own and why do you own it?"
WB - Write an essay on why you would buy the company at the price

Sum of Parts

Here is the story of an interesting trade that I closed at the end of last month. I was running my screens the first weekend of March and encountered this stock. Here are the vitals:-
Price to Book - 1.2
Price to Earnings - 2.0
This meant that you could get more than 40% return on this stock just from earnings. It seemed too good to be true!!! I dug further on this stock - Thermodynetics(TDYT) and found that they had reorganised after the end of the last fiscal and now owned only one subsidiary. The subsidiary - Turbotec - is listed in the London AIM market and has been trading at GBP 0.70. TDYT owns 56.32% of Turbotec. On a per share valuation basis, this puts the value of the investment in subsidiary at USD 2.44. There were no other major liabilities on the balance sheet. The stock was trading at around USD 1.65. I didn't know much about the industry segment TDYT was in - heating, cooling and refrigeration applications.
I immediately placed an order and ended up with shares averaging 1.68 in the next two weeks. As is my practice for such trades, I immediately placed a sell order - good till cancelled
- at my target price of USD 2.40. The order executed at the end of the month. A good return of 36.6% in less than a month's time!!!

Damn Right: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger

I was interested to know more about Charlie Munger after reading the almanac. The opportunity presented itself in the form of this book. I had read Janet Lowe's Warren Buffett Speaks: Wit and Wisdom from the World's Greatest Investor some years ago as well.

A few things about Charlie comes out:-
* Love of books - biographies and other non-fiction
* Great thinking ability
* Charlie's personality hidden behind the curmudgeonly shell
* Social Responsibility through support of various causes like abortion rights and health care

Even an accomplished author like Janet Lowe is unable to do justice and unravel the life, thoughts and business history of the complicated personality of Charles Thomas Munger. The book is divided into various chapters, not so much in a chronological fashion. There are some of his speeches reproduced in the appendix as well.

Buffett 2006 Letter

The 2006 annual letter from Berkshire Hathaway Chairman Warren E. Buffett makes an interesting read (Tell me something new!!!)

I was attracted to where he explains about the Equitas deal where Berkshire re-insures Equitas against upto $13.9 billion claims for securities and cash of $7.12 billion. Assuming the 10.4% return of S&P 500 as laid out in the letter, they will break-even in 6-7 years and changing the return to 21.6%, the break-even would be in 3-4 years. In Buffett's estimate, the payout period for the $13.9 billion is as long as 50 years. Just one word to describe the deal - ingenious!!!!!!!!!!!

India Budget 2007-08 and 2006-07 report card

Indian Budget was presented today. A few quick observations:-

On Economy:-
* A 9.2% growth in GDP with services and manufacturing growth at more than 11%
* Real Growth (i.e.inflation adjusted) per capita income is 7.4%
* A high level of savings rate at more than 30%
* Fiscal Deficit at 3.7% for 2006-07 and budgeted at 3.3% for 2007-08

Areas of concern:-
* Money Supply (M3) grew by 21.3%. High inflation risk.

Structural Initiatives/Changes:-
* Social Security Net to be expanded to cover the heads of 80 lakhs (8 million) rural landless households not covered presently. Government proposes to pay the 50% of premium of Rs 200 (approx USD 5) per year.
* Government plans to acquire RBI's 60% stake in State Bank of India. Why?
* Proposes to use a small part of the foreign exchange reserves without the risk of monetary expansion for financing infrastructure. RBI will be assured of a return higher than the average rate of return on its incremental investment.
* Proposal to set up an autonomous Debt Management Office and as a first phase a middle office, in a move towards better fiscal discipline.

Mortgages
* Announces creation of "Reverse Mortgage" through National Housing Bank.
* Creation of Mortgage Guarantee Companies I assume, along the lines of Freddie and Fannie.

Taxation:-
* Asset Management Services provided by individuals will be levied service tax.
* Small and Medium Enterprises (with less than 1 crore (10 million) in taxable income) will have a reduced rate of income tax.
* Proposal to grant pass-through status to venture capital funds in respect of investments in venture capital undertakings in biotechnology; information technology relating to hardware and software development; nanotechnology; seed research and development; research and development of new chemical entities in the pharmaceutical sector; dairy industry; poultry industry; and production of bio-fuels and for investment in hotel-cum-convention centres of a certain description and size.
* Definition of capital gains to extend to include certain works of art
* Proposal to raise the rate of dividend distribution tax from 12.5 per cent to 15 per cent on dividends distributed by companies
* Proposal to raise the dividend distribution tax on dividends paid by money market mutual funds and liquid mutual funds to 25 per cent for all investors.
* Proposal to bring ESOPs under Fringe Benefit Tax

Influence: Psychology of Persuasion

I just finished reading Influence: Psychology of Persuasion by Robert B. Cialdini, Ph.D. Charlie Munger of Berkshire Hathaway recommends it in his Almanack.

Robert Cialdini discusses the six categories of "weapons of influence" used by "compliance" professionals. To list them:-
1. Reciprocation: The Old Give and Take.....and Take
2. Commitment and Consistency: Hobgoblins of the Mind
3. Social Proof: Truths are us
4. Liking: The Friendly Thief
5. Authority: Directed Defense
6. Scarcity: The Rule of the Few

The basic premise of the book is that there are "hot-buttons" that can be and are used to extract automatic responses from human beings. We have developed, consciously or unconsciously, short-cuts for dealing with everyday challenges or "click" and "whirr" actions. In the words of the author:
"You and I exist in an extraordinarily complicated stimulus environment, ...... To deal with it, we need shortcuts. We can't be expected to recognize and analyze all the aspects in each person, event and situation we encounter in even one day....we must very often use our stereotypes, our rules of thumb to classify things according to a few key features and then to respond mindlessly when one or another of these trigger features is present."

"....Sometimes the behavior that unrolls will not be appropriate for the situation, because not even the best stereotypes and trigger features work every time. But we accept their imperfection, since there is really no other choice. Without them we would stand frozen-cataloging, appraising, and calibrating- as the time for action sped by and away."

What is surprising is the nearly mechanical process in which all the six weapons can be activated, and the consequent exploitability of this power by anyone who knows how to trigger them. The author compares it to Jujitsu where the practitioner exploits gravity, leverage, momentum and inertia. Paramount to all of this is the ability to manipulate without the appearance of manipulation.

One of the techniques used commonly for all the weapons is the contrast principle. I have experienced it first hand while I was trying to buy my first house in the United States. My realtor took me through some of the not so well-kept houses that were priced within my low range and then took me to the one that was at the high range which would earn him higher commission. The order in which it was presented was interesting. I was tempted; however, unwittingly, I ended up using the defense that the author prescribes - gave my realtor an excuse about how I had no immediate access to the extra funds that would be required for down payment to that particular piece of property.

How does this apply to the business at hand - of buying securities? Have you had to compare a stock that is now cheaper from what it was a month ago? Or have you had to compare two stocks that are priced differently despite different EPS?

Let me discuss one of the techniques here
Reciprocation - Watch the technique used by Amway Distributors and any other process that starts with uninvited gifts. It can work in two ways - an obligation to repay favors we have received or an obligation to make a concession to someone who has made a concession to us. In the second case, the compliance practitioner starts with a bigger request and after a few "No"s ratchets it down to smaller ones. The author calls it the 'rejection-then-retreat' technique.

The good thing about the book is that it is replete with anecdotes and detailed instances of the weapons in practice. The other is having outlined the use of the weapons, the author goes on to talk about how to defuse its effects. This is where the academic nature of the book ends and practicality begins, in my opinion. Let me end the review with author's motivation for writing the book. In his own words from the epilogue to the book:-

"..When making a decision, we will less frequently enjoy the luxury of a fully considered analysis of the total situation but will revert increaingly to a focus on a single, usually reliable feature of it.
When those single features are truly reliable, there is nothing inherently wrong with the shortcut approach of narrowed attention and automatic response to a particular piece of information. The problem comes when something causes the normally trustworthy cues to counsel us poorly, to lead us to erroneous actions and wrongheaded decisions...one such cause is the trickery of certain compliance practitioners who seek to profit from the rather mindless and mechanical nature of shortcut response..
...more than evasive action, I would urge forceful counterassault. There is an important qualification, however. Compliance professionals who play fairly by the rulse of shortcut response are not to be considered the enemy; on the contrary, they are our allies in an efficient and adaptive process of exchange. The proper targets for counteraggression are only those individuals who falsify, counterfeit, or misrepresent the evidence that naturally cues our shortcut responses.....
In short, we should be willing to use boycott, threat, confrontation, censure, tirade, nearly anything to retaliate.....
It is important to recognize, however, that thier motive for profit is not the cause fo hostilities....the real treachery, and the thing we cannot tolerate, is any attempt to make their profit in a way that threatens the reliability of our shortcuts."

Emerging Market Century

I had a chance to attend a Lunch meeting by CFA Society of Washington DC. The title of the topic had caught my attention - The Emerging Market Century. The speaker was Antoine van Agtmael. It was also an introduction to his book to be published in Jan 07. What I didn't know was that Mr.Agtmael had coined the term Emerging Markets to describe the Third World. It was an interesting talk. He took World is Flat to the next level. The talk also touched upon the resource crunch we are going to face not only in oil but also water and other natural resources.
I pre-ordered the book in Amazon and received it today. I am eagerly looking forward to reading it soon.

How much should you pay?

Here is part of a write-up I gave my management explaining the use of P/E based valuation of ABC Company we were looking to acquire.

A Note on the profit based valuation process of ABC
"The basic objective of the valuation was to determine what we can pay for a company that can generate about 25% return on equity.

In trying to determine a multiple of profits we can pay for such a company, we would need to find out the organic (meaning, without additional infusion of capital) growth potential that it has. The metric to determine this growth is a function of current ROE and percentage of the retained current earnings. To explain this concept, intuitively, a company with a zero ROE would have no growth since it is not generating any capital for redeployment in the business and would work with same capital as it had in the beginning of a given period. Either the ROE has to turn positive or there has to be additional capital infusion for it to have any growth. For a company generating positive return on capital, the organic growth would, hence be a product of the capital it retains and the ROE. This is the first of the bases of valuation.
Arguably, either of these variables can change – ROE due to change in product profitability or similar and capital due to additional infusion/withdrawal. However, this is a decision down the line that we (as a controlling stakeholder) will make and hence, should not pay the current owners of ABC for. Hence, this metric of organic growth has no subjectivity involved."

Continuing on the above part of my note:-
ROE is the net profit available to shareholders divided by Shareholder's Equity (Book Value). This can be easily found by dividing EPS by Book Value Per Share.