Monday, April 25, 2011

Stock Market is loony for growth ( Orbit Exports Ltd )

The crowd psyche has excessive predisposition towards growth, more so if it is accompanied by consistency. Our personal leanings on any scenario that we refuse to appreciate have little to do with investing success. That is why the quote "Don't argue with the tape" or "Market is always right". For example I don't like a 20% growing company at 40+ trailing PE no matter what the organisation or who runs it, no matter how seductive the growth prospects. This mindset has helped me more often than not. I never became a victim to private sector Insurance mania, satellite TV (Dish TV), micro finance etc.

However, market gives two hoots about my opinion. Market will pay heady multiple for growth oriented stocks no matter what the downside. That is dangerous for small cap investor, as some small caps may never recover. Being greedy, I follow the Lynch maxim, Big Stocks small moves, Small Stocks big moves. Big moves can be in either direction !

Some Mistakes

As a micro cap investor you have to be vigilant to avoid big move on the downside, or one could lose 70% or more on paper very quickly. 30% volatility in micro caps is similar to 10% volatility in big cap, don't even think of stop losses.

The mistake I make often is to wait too long for a stock to get cheap, something I may not learn, but this has helped me more than otherwise in toto. I want to share a story on two stocks. One of them that I missed was Spice Mobiles in early 2010 around 20-30 Rs. I wrote briefly about it on here when the price was around 50 Rs. At the time Spice Mobiles was a 100 Crore entity in 1 Lac Crore market of handsets. It was not merged and name of company was Spice Mobiles Ltd.Stock went to 150 Rs over next 6 months.

Second mistake was with Orbit Exports, I recognised it at 15 Rs with A class management and a niche with excellent clients in US but did not buy it. Since I keep looking at downside more than upside, with each rise my aversion grows. I think it has steam left but I don't buy if in my world view downside is disturbingly high.

Aim for achievable, Show me the Money

Contrary to what the general perception may be I am not looking for 10 or 20 bagger or 50 bagger, that is pure serendipity. I welcome if they so turn out to be. I am just looking for a simple 5 bagger in 4-5 years, that is not at all bad if you compute the compounding.

A five bagger in five years translates to a 25 bagger in 10 years and 625 bagger in 20 Years with a much higher probablity than investing in blue chips like IDFC Ltd and holding them for my grandchildren. Since nobody can look that far into future of any enterprise it pays to be medium term oriented and straining your mind only with what your regular corrective vision glasses render, over reliance on telescopes can injure investing performance.

As a rule I don't buy hope and hype, dreams of prosperity, bright future prospects or any new and improved industry. I believe in my company showing me the money, here and now.

Disclosure: Not invested in either of two

Saturday, April 23, 2011

Warren's why and wherefore

Several books have been written on this topic, Buffett's acquitisions over the years make for investing study into rationale and motivations. Posting some content aggregated from various sources. I found the statement made in context of National Indemnity  "The key is you can’t fire people if they don’t write business, or they’ll write business" and "Tell me how you'd attack that business? You wouldn't want to anyway, as the market's not big enough. " for Larson Juhl very smart. Acme bricks resounds Lynch as well who quoted on heavy stone / quarry industry as moat due to transportation cost.

In recent times Buffett mentions that growth does not matter to him in certain businesses, he can afford to say so by categorising those businesses as lasting steady stream of century lasting annuities. He did not mention so during 50s and 60s. Infact, I remember having read, "I became rich by finding companies with strong growth in earnings". Now that he is in business of acquiring family businesses he is Ok with losing  1 billion $  to acquire business that can earn 100 Million $ in current year (i.e. 10% ROI) and probably 150 million $ a decade from now. That fortunately is not a problem we have to live with as small investors. His wisdom follows:

Buffett's reasons to invest in Harley-Davidson ?

He answers that any company where one can get customers to tattoo business's name on their body has quite a strong brand. He had to think what is the probability that they will not pay him back and would he want to own the company if they did not, basically that the equity isn’t worth zero. I always think about what I would do if a nuclear bomb went off or if Bernanke ran off with Paris Hilton to South America.

BYD [Buffett’s recent Chinese investment] seems like a speculative or venture capital investment, instead of a “value” investment. Could Buffett explain?

BYD is not some early-stage venture capital company. The founder is around 43 years old. They’re a main manufacturer of rechargeable lithium batteries, from a standing start. Then they became big in cell phone components, with a huge position. They recently entered the auto industry, and from zero, rapidly made the best-selling [Chinese-manufactured] car model in China, against Chinese joint ventures with leading manufacturers. This is not unproven. It’s not speculative. They hired 17,000 engineering graduates at the top of their classes. It’s a remarkable aggregation of talent. Batteries are totally needed in the future of the world.

Could you talk us through your thinking of the acquisition of Larson-Juhl?

On December 17, 2001, Berkshire Hathaway announced that it was acquiring Albecca (known as Larson-Juhl), the nation's leading provider of custom picture frames.
Craig Ponzio, the owner of Larson-Juhl called me, told me about his business, its sustainable competitive advantages, its financial characteristics, and the price he wanted. Shortly thereafter, he came to visit me at 9am and by 10:30 we had a deal. I haven't seen him since.

The company has $300 million in revenues, earns $50 million in pre-tax profits, ties up no capital, is growing slowly, and distributes every dime of profit. There are about 18,000 picture framing shops in the United States, mostly very small businesses with a few hundred thousand dollars per year in sales. They can't afford to have much inventory, so they show a catalogue to a customer who chooses the frame. Then, if they call Larson-Juhl before 3pm, 85% of the time the frame will be there the next day. Larson-Juhl and its customers are focused on service, not price.

Larson-Juhl calls on its 18,000 customers an average of five times/year. It has an incredible distribution system. Tell me how you'd attack that business? You wouldn't want to anyway, as the market's not big enough. Larson-Juhl has a HUGE moat. I always ask myself how much it would cost to compete effectively with a business. With businesses like these, nothing's going to go wrong. If you bought 20 of them, 19 of them would work out well.

Craig wanted to sell to me because he didn't want to waste a year doing a deal that might fall through at the end. With us, it's 100% certain that the deal gets done, and he can enjoy life.

Why did he invest in Anheuser-Busch?

In the case of Anheuser- Busch, I bought 100 shares 25 years ago so that I would get the annual reports (you get the annual reports a little quicker if you own the stock in your own name). So, I’ve been reading the company’s annual reports for 25 years. Recently, beer sales have been flat. Wine and spirits are growing, at the expense of beer, and Miller has been rejuvenated to some degree. So, Anheuser-Busch has been experiencing very flat earnings; they’ve had to spend more to maintain share and even do a bit of promotional pricing. They are going through a period that is certainly less fun for them than was the case a few years ago.

It’s been a fascinating industry over the past 50 years. Omaha used to be a brewing town and Storz beer had 50% of the local market, but then the national brands took over.

Anheuser-Busch will have a strong position for a long time. The beer business is not going to grow significantly in the U.S., but worldwide beer is popular in a great many places, and Anheuser-Busch has a very strong position. I would not expect the earnings to do much for some time, but that’s fine with us.

In beer, you don’t see the rise of generic brands, as we’ve seen in so many other categories. But beer consumption per capita is going nowhere.

Americans drink about 64 ounces of liquid per day. 27% of that is soda (11 ounces are Coke products), beer is about 10% and, despite the rise of Starbucks, a fine company, coffee has gone down and down over time.

[CM: There used to be hundreds of brewers. I think the trend toward giant companies [dominating the beer industry] is permanent.]

What was the thinking behind the McLane purchase?

McLane is a wholesaler to convenience stores, quick-serve restaurants, Wal-Mart, movie theaters and so forth.

Wal-Mart, for very good reasons, wants to specialize on what they do extremely well. We were approached by Goldman Sachs to buy the business a week ago. It makes sense for both sides. It was a sideline business for Wal-Mart. Their ownership of McLane resulted in certain people who would be logical customers not to do business with McLane because they didn't want to do business with a competitor. We'll be seeing them soon to explain that they can sleep well at night buying from us.

A representative of Wal-Mart, the CFO, came up to Omaha. In one hour, we had a deal and shook hands, and when you shake hands with Wal-Mart, the deal is done.

It serves presently 36,000 of the 125,000 convenience stores in the United States, and has 58% share among the largest chains. To each store, it sells about $300,000 of products/year. McLane also serves 18,000 quick-serve restaurants, mainly those operated by YUM Brands (Taco Bell, Pizza Hut and KFC).

It's a tough business. You have Hershey and Mars on one side and 7-11 Eleven on the other side, so you have to work hard to earn 1% pretax. [Tilson - If McLane earns 1% pre-tax on $22 billion in sales, that's $220 million, so Buffett may have bought this business for 6.6x pre-tax earnings. I think this is a good price, especially if the business can grow substantially under Berkshire, but not a steal -- the guys at Wal-Mart aren't fools. But I think they let it go for a below-market price to Buffett because their biggest concern is that the business continue to be a reliable supplier to their stores. Such a low-margin business has little room for error, and it could get into trouble (as other similar companies have) under the ownership of a financial buyer that used too much leverage or tried to tinker with its operations.]

    * Source: BRK Annual Meeting 2003 Tilson Notes
    * Time: 2003

How did the Clayton Homes purchase come about?

Clayton Homes is the class of the manufactured home industry. The deal came about in an unusual way. Every year, a class (about 40 students) from the University of Tennessee comes to Omaha. They visit some sights and then we a have classroom session for a couple of hours. Afterward, they typically give me a football or basketball. Last year, Bill Gates happened to be in town. This year, we had a good session and when they got through, they gave me a book, the autobiography of Jim Clayton, the founder of Clayton Homes. He'd written a nice inscription. I said to the students that I was an admirer of Jim's. I read the book and called Kevin Clayton, Jim's son, and said how much I'd enjoyed his dad's book. I said if they ever decided to do anything [regarding selling the company], we'd be interested and I told him what price I'd be willing to pay. A few phone calls later, we had a deal. That's the way things tend to happen at Berkshire.

The manufactured home industry got in a lot of trouble. They'd gone crazy with credit and when you go crazy with credit, you get into a lot of trouble. Look at Conseco and Oakwood, which went into bankruptcy. The industry lost the ability to securitize receivables and was in the tank. There were 160,000 new manufactured homes this year, but there were 90,000 repossessions, so this hurts demand. For the strong, like Clayton, especially with a backer like Berkshire, it should be a good time in the industry. And it's a big industry -- about 20% of new homes are manufactured. We can put you in one for $30/square foot. Compare the prices -- that's a deal.

Competitors admit that Clayton is the class of the field, but even for Clayton, financing was hard. The lenders had gotten burned. Clayton did a securitization earlier this year, but [to get the deal done, they] had to keep more of the risk on their books

[Later in the meeting, in response to a question, Buffett commented further on Clayton Homes:] In the manufactured housing industry, everyone is losing money, but Clayton is making money. Most of Clayton's houses are sold through 297 outlets that they own. Managers are in a 50/50 profit split with Clayton. This is unlike what was going on in the industry a few years ago, whereby dealers would have a floor plan and the [manufactured housing] company would finance 130% of the purchase price, so the dealer would bring in any warm body. The system was designed for disaster. At Clayton, if a dealer takes in an inadequate down payments, it's his problem and he has to take care of repossessing it. This creates the right incentives.

If you read Jim Clayton's book [First A Dream], he tells about the first home he sold [when working for someone else] and all of the funny business and gaming of the financing. These activities are coming home to roost in a huge way among the manufacturers and those who financed them. There's such a stain that Clayton is only one that can securitize, and without us, not to the extent they wanted. They are a class player and have the right systems in place with the right incentives. We will not securitize -- we will keep it for the portfolio.

You're right [he was speaking to the questioner] that if you see companies with lots of gains on sales, be suspicious.

    * Source: BRK Annual Meeting 2003 Tilson Notes
    * Time: 2003

Reasoning behind the National Indemnity investment?

We are very big in insurance and having the wrong incentives in place could be very harmful.

[Buffett had prepared slides and had them put up on the screens in the convention center. Slide 1 showed Berkshire Hathaway’s balance sheet shortly before it bought National Indemnity.]

For 15 minutes each year, Jack Greenwald [the owner of National Indemnity] would get frustrated with something and want to sell his company. I told Charlie that the next time he was in heat, bring him to me. So, we bought it in ’67 for $7 million.

[Slide 2 showed premium volume for National Indemnity from 1980 through 2003. It was $80 million in 1980, rose to $366 million in 1986, then declined nearly every year down to $54 million in 1999, and then spiked up to $595 million in 2003. Buffett highlighted the decline from 1986 to 1999 and asked:]

How many public companies in America would see premiums go down every year for such an extended period?

[Slide 3 showed the number of employees at National Indemnity from 1980-2003. The number rose from 1980-86 and then declined from 1986-99, but much more slowly than premiums declined. Buffett noted:]

We never fired anyone – the decline in headcount was solely due to retirements. The key is you can’t fire people if they don’t write business, or they’ll write business. You must be able to tell them that if they write no business, their job is not in jeopardy.

[Slide 4 showed National Indemnity’s expense ratio from 1980-2003, which was as low as 25.9% in a peak year, and as high as 41% in the worst year, 1999. Buffett noted that:]

Some companies would feel that this is unacceptable. [We don’t.] We can take an expense ratio that’s out of line, but can’t take writing bad business.

[Slide 5 showed the combined ratio at National Indemnity from 1980-2003. The combined ratio exceed 100 during a few bad years for the industry in the early 1980s, which is what led to the hard market that peaked in 1986, but National Indemnity’s combined ratio has been below 100 – e.g., the business has been profitable – in every year for the past 20. Buffett pointed out:]

In 1986, our combined ratio was only 69.3 because we did the most volume ever that year, up to that point [the company has done more volume in the past few years]. We coined money when we wrote a lot of business, and made a little when we didn’t. We’re the only company like this. We’ll have a high expense ratio when business is slow.

National Indemnity was a no-name company when we bought it, and has no copyrights, patents, etc. to distinguish it, but they have a record like no-one else because they had discipline.

You can’t run an auto or steel company this way, but it’s the best way to run an insurance company.

[CM: Nobody else does it, but to me it’s obviously the only way to go. A lot about Berkshire is like this. Being controlling owners is key – it would be hard for a committee to make these kinds of decisions.]

    * Source: BRK Annual Meeting 2004 Tilson Notes
    * Time: 2004

Reasoning behind the HomeServices investment?

HomeServices will grow. It owns 15-16 local real estate firms, which retain all of their local identities – akin to the whole Berkshire model. Managers operate them as if they owned them themselves. We have no national identity, unlike Cendant, which operates under a few big names.

There’s no question that we’ll buy a few – or a lot – of [real estate brokerage] companies over the next 10 years. It’s a great company with great management. Last year, we participated in $50 billion of transactions – but this was only a small percentage of the national total. We’re big in California, Minnesota and Nebraska.

It’s a good business, but very cyclical. It’s very good now. We’ll go through a bad period, but we’ll keep buying. I don’t know how big it will become, but it’s conceivable that as we grow, we’ll add things like buying furniture. When people buy a new house, they need a lot of things.

[In response to another question about whether the internet will threaten the commission structure of real estate brokers like HomeServices, Buffett replied:]

I think commissions in HomeServices are sustainable. Barry Diller is interested in the space via Lending Tree, and the internet is a threat to any business, including real estate brokerage. But when I think about the process of owning a home, the for-sale-by-owner (FSBO) was with us 50 years ago and it is now [but it hasn’t affected commissions]. My guess is that 30 years from now, a very significant percentage of home sales will be done through the brokerage system like today’s, though there are people trying to change it.

[CM: [speaking to Buffett]: You tried to change it dramatically in Omaha, and you fell on your ass. [Chuckling.] You tried to take home listing business from the Omaha World Herald with your little paper and failed.]

    * Source: BRK Annual Meeting 2004 Tilson Notes
    * Time: 2004

We don’t think the way homes are bought and sold will change very much. Some will disagree, but we don’t think the internet will change this. [Buying and selling a home] is the biggest financial decision most people will make] and people will continue to want to have a 1-on-1 relationship with a real estate broker. [It also will be] a local business, so we’ve retained the local identities.

It’s almost certain that we’ll be a lot bigger [in this business] in 5-10 years. It depends on how many acquisitions we make, but we’re a good buyer and owner.

[CM: As to whether we’d prefer to buy brokerages or real estate, obviously we like brokerages better.]

Why did Buffett buy Acme Bricks and Justin Industries ?

In July 2000, Berkshire Hathaway bought 100 percent of Texasbased Justin Industries for $600 million. The company has two divisions: Justin Brands, which comprises four brands of Western boots, and Acme Building Brands, with companies that make bricks and other building products.

Cowboy boots and bricks. It is one of Berkshires most interesting, and most colorful, acquisitions. And it says a great deal about Warren Buffett.

In many ways, Justin epitomizes all the business strengths that Buffett looks for. Clearly, it is simple and understandable; theres nothing particularly complex about boots or bricks. It represents a remarkably consistent operating history, as a look at the separate companies will show; all have been at the same business for many decades, and most are at least a century old. Finally, and most especially, Buffett recognized favorable longterm prospects, because of one aspect that he highly admires: in what are essentially commodity industries, the products have achieved franchise status.

In July 2000, Berkshire Hathaway bought 100 percent of Texasbased Justin Industries for $600 million. The company has two divisions: Justin Brands, which comprises four brands of Western boots, and Acme Building Brands, with companies that make bricks and other building products.

Justin Brands

The company that is now Justin began in 1879 when H. J. ( Joe) Justin, who was then 20 years old, started making boots for cowboys and ranchers from his small shop in Spanish Fort, Texas, near the Chisholm Trail. When Joe died in 1918, his sons John and Earl took over and in 1925 moved the company to Fort Worth. In 1948, Joes grandson John Jr. bought out his relatives (except Aunt Enid ), and guided the business for the next fifty years.

John Justin Jr. was a legendary figure in Fort Worth. He built an empire of Western boots by acquiring three rival companies, worked out the deal to buy Acme Bricks in 1968, and served a term as Fort Worth mayor. He retired in 1999, but stayed on as chairman emeritus, and that s why, at the age of 83, it was he who welcomed Warren Buffett to town in April 2000.

Justin Boots, known for rugged, long-lasting boots for working cowboys, remains the flagship brand. But Justin Brands includes other names.

Nocona, founded in 1925 by Enid Justin. One of Joe Justins seven children, Enid started working in her fathers company when she was twelve. After her nephews moved the family business from the small town of Nocona, Texas, to Fort Worth in 1925, Enid set up a rival company in the original locale. Against all odds, she built a success. Fierce competitors for years, the two companies were joined under the Justin name in 1981. Enid, who was then 85, reluctantly agreed to the merger because of her declining health.

Chippewa, founded in 1901 as a maker of boots for loggers, today makes sturdy hiking boots and quality outdoor work boots. It was acquired by Justin in 1985.

Tony Lama, which dates back to 1911, when Tony Lama, who had been a cobbler in the U.S. Army, opened a shoerepair and boot-making shop in El Paso. The boots quickly became a favorite of local ranchers and cowboys who valued the good fit and long-lasting quality. In recent years, for many the Tony Lama name has become synonymous with high-end boots handcrafted from exotic leathers such as boa, alligator, turtle, and ostrich, many with prices near $500. In 1990, Tony Lama Jr., chairman and CEO, agreed to merge with archrival Justin.

Two groups of people buy Western-style boots: those who wear them day in and day out, because they cant imagine wearing anything else; and those who wear them as fashion. The first group is the heart of Justins customer base, but the second group, while smaller, does have an impact on sales volume as fashion trends twist and turn.

When big-name designers like Ralph Lauren and Calvin Klein show Western styles in their catalogs, boot sales climb. But fashion is notoriously fickle, and the company struggled in the late 1990s. After a peak in 1994, the sales of Western boots began to decline. In 1999, Justins stock price dipped below $13.

John Justin Jr. retired in April 1999, and John Roach, former head of the Tandy Corp., came in to lead a restructuring. In just over a year, the new management engineered an impressive turnaroundadding new footwear products, consolidating the existing lines to eliminate duplicate designs, and instituting efficiencies in manufacturing and distribution. In April 2000, the streamlined company announced first quarter results: footwear sales rose 17 percent to $41.1 million, and both net earnings and gross margins increased significantly.

Two months later, Berkshire Hathaway announced it had reached an agreement to buy the company, prompting Bear Stearns analyst Gary Schneider to comment, This is good news for employees. Management made all the changes last year. Theyve already taken the tough measures necessary to lower costs.

Today the boot division of Justin has 4,000 vendors and about 35 percent of the Western footwear market; in stores that specialize in Western apparel, some 70 percent of the boots on the shelves are Justin brands. Most prices start at around $100. In the higher price brackets (several hundred dollars and up), Justin has about 65 percent of market share.

Acme Building Brands

The other division of Justin Industries is also a pioneer Texas company that is more than a century old. Founded in 1891 in Milsap, Texas, Acme became a Justin company in 1968, when John Justin Jr. bought it. Today, Acme is the largest and most profitable brick manufacturer in the country.

Because long-distance shipping costs are prohibitive, bricks tend to be a regional product. Acme dominates its region (Texas and five surrounding states) with more than 50 percent of market share. In its six-state area, Acme has 31 production facilities, including 22 brick plants, its own sales offices, and its own fleet of trucks. Builders, contractors, and homeowners can order bricks direct from the company, and they will be delivered on Acme trucks. Acme sells more than one billion bricks a year, each one stamped with the Acme logo, and each one guaranteed for 100 years.

Demand for bricks is tied to housing starts and, therefore, subject to changes in interest rates and in the overall economy. Even a run of bad weather can affect sales. Nonetheless, Acme fared better during the techno-crazed 1990s than the boot companies, and today is still the chief Justin money-maker. In addition to its bricks, Acme Building Brands includes Featherlite Building Products Corporation (concrete masonry) and the American Tile Supply Company, maker of ceramic and marble tiles.

Why was Benjamin Moore acquired ?

127 year old reliable business with premium brand aka Mercedes of paint companies. It is not biggest, a 10th largest specialty paint producer.
 A video follows with an executive of Benjamin Moore

Thursday, April 21, 2011

Barbarians at the Gate & Microcap investing

This book is not a textbook on investing, written more as a thriller and entertainment novel. Flamboyant, profligate and profane Ross Johnson rips off couple of biggest companies. Based on a true story this novel inspired a movie Madness of leveraged buyouts in 80s makes it evident why capitalism is broken. After a course of this book, any family that nurtures a culture in business would forever banish the thought of selling their business to greedy bidders.

Black Book of Microcap Investing

The following nifty book appears to offer practical counsel through my 2 minute scan of the book. If you are thrifty you can download it from here I have no idea who put the book there nor will I answer whether I downloaded it from there, in other words, publisher can't sue me :) Amazon Link. Enjoy the process.

Monday, April 11, 2011

Book : Psychology of Intelligent Analysis & Article : Triple U Investing

Enjoying this fine work on behavioral domain. Whilst the book was intended for CIA and intelligence agents with backdrop of military and political illustrations, it would make a more apt textbook for just about any analyst, business or otherwise.

One could have it from Amazon or download from CIA library for free,

It would make one a better analyst, expose the limitations of our mind, memory, aid to provide the tools to overcome those shortcomings. Taleb's work exposed our dope-ness for narrative and this affirms our chump-ness for analogies. In all work to do with analysis, decisions ought to be arrived at with incomplete information. One interesting aspect is, the very circumstances under which analysts work, i.e. are presented with bits of information leading to clearer view towards the end, is the most vulnerable and error prone from our cognitive ability vantage point.

Several limitations, including maximum number of simultaneous thoughts, competing hypothesis, tendency for satisficing and selective perception and failure to consider 'diagnosticity of evidence' and all of psychology schemata applies to our field of investing. Simultaneous evaluation of competing hypothesis causes greater cognitive strain.

In my readings several religious books too aver to our mental state unable to grasp contradictory viewpoints. We either see a twisted object lying on the ground as either a rope or snake, not both, at least not at the same moment. Our standards may have changed and we like to over simplify but in another world measuring scales can be radically different or even in ours at a different time in past, person who could interpret a sentence in maximum possible permutations was deemed most erudite, not the one who could stick a singular simplified view.

Interesting essay, I can relate to it : Unknown, Unknowable and Unique Investing by Zechhauser.