The Intelligent Investor – 17 – Four Extremely Instructive Case Histories

Posted on December 8, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

Mr. Graham has mentioned a few points which need to be check for any of the companies in which we are planning to make an investment. And if the company having such points then should avoid it is a better choice.

The company not paying income tax through earning profits. We must have doubts about the earning of the company if the company continuously not paying income tax. We need to check whether the company has any tax benefits or not. If the company has any tax benefits then we need to check where such benefits are going to expire and need to adjust tax benefits for our calculation of future estimation of profitability / per-share earnings.
Overpriced giant companies. Giant companies are those which have shown decent growth in the past and gaining market share. Thus, such companies have won the trust of the investors and available at a higher valuation. We need to understand that not always a great company can be a great investment. Also, we need to stay away if the company available at an extreme higher valuation. One of the current giant IT companies was traded on 200+ of P/Ex during the IT bubble and after that company has posted sales & profitability growth of 30%+ but the stock has given return ~7-8% CAGR during that period.
Interest coverage is less than 5x. If the company cannot able to generate pre interest profit 5x higher than the interest amount then any unforeseen circumstances can affect the profitability of the company.
The company involves frequent mergers and acquisitions. Frequent merger and acquisition turn a simple financial statement into a complex which becomes much difficult to understand. In addition, the company can hide many things through mergers and acquisitions which becomes difficult to identify.
Merger and acquisition are huge in size compare with the size of the company and also, funded through huge debt. Such M&A can create trouble for the company if not played well. The majority of such M&A has failed badly. One of the steel company which has done an acquisition of the company which is huge in size by taking a huge debt.
Here, we can see that the company has faced a hugely difficult to get survived. Also, the company has to take a huge debt + equity issuance.
Acquisition of the company at a higher valuation. When one company has acquired another company at higher valuation then it will consider as a capital misallocation and it will take time to cover the extra value which the company has paid. If the company has paid a huge premium + balance sheet also not stronger than it can be troublesome.
Frequent merger and acquisitions. This will create trouble for an investor to understand financial statements. In addition, the company can hide many things under such frequent M&A and can boost up revenue and profitability in a fraudulent way.
Deferred debt expense which is greater than entire shareholders fund
Amortization of deferred debt expense
The company has a debenture that is traded at a huge discount then also, the company buying warrant.
Increasing debt in more peace compared with the revenue
We need to deduct preferred stock payment, debenture payment from available cash & investment of the company to reach the conclusion regarding available cash & investment for the common stockholders.
Checking a liquidity position of the company
Expansion strategy, if expansion is huge enough that it has a higher probability to get fail, the profitability of the company can wipe out. And if such a huge expansion funded through external fund then can be the hero or zero kinds of situation arise.
One of the chemical company of India has announced a huge expansion plan which is a hero or zero kinds of plan
Here, we can see that the company can able to grow its revenue and profitability after the huge Capex which has helped the company to get survived very well.
The company owning huge preferred, warrants and convertibles then need to check such companies with more patience or should avoid it.
Changes into the method of arriving at the pension
Changes into the depreciation rates
Stock trading at Extreme cheapness. When things available at cheaper valuation then we need to be cautious and ask to question & try to find out the reason for cheap valuation.
Avoid hot stocks and hot fancy businesses
An initial public offering of shares in a basically worthless company. IPOs of the company which are not good in the balance sheet and just coming up with an IPO due to fancy in a sector or in the market.
Inspection from SEBI or other regulatory authorities. When we come across such news then we need to study carefully with that company.
Few more things to avoid – MY LEARNING FROM MY MISTAKES
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

WARREN BUFFETT’S LETTER – 1996

Posted on October 20, 2018 by Jimit Zaveri under Bibliophile

Warren Buffett’s Letter – 1996

Acquisitions

Kansas Bankers Surety (KBS)

The company is an operating into the business of insurance which has a presence in 22 states, decent underwriting record with Don Towle as a manager. They made a deal to acquire a company at $75 million.

FlightSafety International

The company is the world’s leader in the training of pilots. The company operates in 41 locations, outfitted with 175 simulators of planes ranging from the very small, such as Cessna 210s, to Boeing 747s. About half of the company’s revenues are derived from the training of corporate pilots, with most of the balance coming from airlines and the military. They made an acquisition at $1.5 billion.

WB 1996 01

We need to prepare a list of the errors which can be dangerous for the health of our investment and work to avoid those errors. If we work on the avoiding mistakes then we can win 50% of the battle.

List of mistakes which I have experienced during my investment journey –

Never ignore the true value of the company—Every business has some value and that we should not have to ignore. If we commit such a mistake then the market will defiantly punish us. Be careful with the true worth of the company and only buy it when it falls below its true worth. And if business not available below its true worth then ready to missed that opportunity. Loss of opportunity is better than the loss of capital.
Don’t buy HOT —-If we buy the hot business such as recent trend, new IPOs, business on which everyone is bullish etc., then we must have to exit it at the proper time. So if we aren’t able to exit at the proper time then it’s better to let it go such opportunities. If we buy HOT then that HOT will BURN our portfolio.
Buying a high leverage business — We need to avoid a business which has a huge borrowings, such borrowings can kill the business and also kill our investment journey.
Using the wrong valuation method — Every business will not get valued with a similar valuation matrix. We need to identify the nature of the business and then value a particular business. Such as we should not use the valuation matrix of growing non-cyclical business for cyclical business, should not use the valuation matrix of assets light business for assets heavy business and vice-versa. If we made such a mistake then whether we might miss a decent investment opportunity or we might lose our capital.
A mistake of buying a story, not a fundamental — I have never ever made such a mistake because I am a hard-core lover of numbers. But I have seen many of the people who always focus on the story and also which is very trending to the market. I believe that without the support of numbers, no story can survive for long. In the year 2014-15, Logistics stocks due to GST gets a trending story but due to lack of good numbers, the story gets failed. People generally avoid numbers due to lack of understanding of it. I firmly believe that “Stories are for kids, not for investors.”
Investing without a process and philosophy — I can overcome this mistake at the initial period of my investment journey and that is only because of my guru – Neeraj Marathe Sir (who always believe on having a process and philosophy for making an investment). I have seen many people who spent lots of time into the market but they do not have any process or philosophy. They change their philosophy as they meet various people. If we do not have our own process and philosophy for making an investment then we will not able to create a successful investment journey. I also learn from my guru that we must have our philosophy in a written format so that we can refer it over a period of time and stop ourselves from occurring a mistake.
Not using a checklist — We should have a checklist for a business, industry, financial, management etc. so that we can focus on the points to study and also not forget any point to study. I am using a checklist for the last 3 years and I can say that having a checklist helps me a lot. My checklist keeps on improving as my experience grows.
Making an investment decision with disturb mind — We should avoid making an investment decision while our mind is disturbed. Disturbance in mind will end up with the faulty investment decision and which can be harmful to our wealth.
Cloning a well-known investors/fund managers — Again I can overcome this mistake at the initial period of my investment journey and again credit goes to my guru. If we have our process and philosophy then we will not try to clone others. I have seen many people who have spent 10-15-20 years to the stock market then also not having any process and philosophy & they clone others. Many of the people have cloning as their investment philosophy because they love to use shortcuts. I always remember the quote of my guru –

WB 1996 02

When Company does not have an opportunity to reinvest earnings at a higher rate than the company should distribute those earnings to the shareholders so that they can use it somewhere for getting a higher return. If the company does not have a good opportunity to reinvest earnings and then also company does not distribute earnings as a dividend then we need to be careful with a company (Question on the capital allocation decision of a management or earnings can be manipulated or business always needs a huge capital to sustain only).

Examples – No/Low growth high dividend payout

Examples – No/Low growth low dividend payout

WB 1996 03

We need to check the above-mentioned factors in the company where we have made an investment and where we want to make an investment. Most important is to gain a market share. The company cannot able to gain market share, though the company has a competitive advantage then that competitive advantage not useful for us. We should not focus on the leadership position of the company rather need to focus on the companies which focus on the manufacturing, distribution, packaging and product innovation. Market leadership can be changed if the company does not focus on the mentioned points.

WB 1996 04

According to Mr.Buffett, paying a higher price does not risk for the good companies compared to paying higher prices for the bad companies.

WB 1996 05

Let me take an example of one the biggest wealth creator company of the Indian stock market—

INFY Chart

If someone has bought this company during the March-2000, at the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all-time high price for calculating returns). Though revenue has grown at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by a good management team. During March-2000, the company was traded at 64x P/E at the low price of Rs.275 and this multiple is common nowadays.

When management of a good business diverts their focus into the business which is not performing well then such decision of the management affect the performance of the business.

WB 1996 06

Example – We have seen examples such as liquor manufacturer enter into the airlines business, airport contraction business has diversified into the power business.

Mr.Buffett has also mentioned the Circle of Competence concept –

WB 1996 07

WB 1996 08

Control on our temptation, control on our emotion towards our investment is essential to survive and create wealth from our investment.

Warren Buffett’s Letters 1957 – 2012

WARREN BUFFETT’S LETTER – 1994 – 1995

Posted on October 7, 2018 by Jimit Zaveri under Bibliophile

WB Letter 1994

Mr. Buffett has mentioned that they are ready to wait for opportunities within their comfort zone. They do not like to capture each and every opportunity but want to capture an opportunity within their circle of competence. He added that they have picked up their best investment when some of the macro factors are at the peak. Here, we can also make an interpretation that we also can make a good investment when the macro is at the peak of worst situations such as 2008 global crisis, 2013 depressed economic growth with policy paralysis, etc.

Own investment approach

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Book Value and Intrinsic Value
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Mr. Buffett has explained how we need to look at the growing business in-terms of earning and not huge growth into the book value.

Berkshire has made an investment into the Scott Fetzer at the beginning of the year 1986 with having a collection of 22 business which is the same in the year 1994. They paid $315.20 million for Scott Fetzer which having a book value of $172.60 million.

Performance of the book value given by Mr. Buffett of Scott Fetzer –

wb_1994_03

We can see that book of the company has not grown but earnings of the company have grown approximate double. Also when Berkshire has made an investment into the company then the company has debt on balance sheet and in the year 1994, the company becomes virtually debt free. Return on equity has been improved well.

Intrinsic Value and Capital Allocation

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Whenever merger and acquisition made by a management then they should have the focus that whether the intrinsic value of the company is increasing or getting diluted.

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We need not make a difficult investment for getting a good return if we can able to analyze business which is easy to understand and its economic characteristic are long lasting then we can get a good payoff for our investment.

They also give priority to the existing investment rather buy a new investment. They compare that which investment opportunity is more beneficial to them.

Mistake Du Jour

Mr. Buffett has mentioned that purchasing a USAir in the year 1994 as his mistake.

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WB Letter 1995

Acquisitions

Mr. Buffett has explained regarding acquisitions that when the company has a business which is performed sometimes and worsen at few times then we need to sell the business when it is performing well. Majority of the company doing same so that when the acquisition of any company happens then majority of the time acquiring company does not get a benefit. We need to carefully analyze that whether acquisition increases a per share intrinsic value for shareholder or not.

Examples of wealth destructor companies through acquisition

One of the medical device company which has done reverse compounding of the wealth of investors –

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One of the wind energy company which has done reverse compounding of the wealth of investors –

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Helzberg’s Diamond Shops

Helzberg’s Diamond Shops was started by the grandfather of Barnett Helzberg, Jr. In the year 1915 with a single store which has increased to 134 stores in 23 states. Sales had grown from $10 million in the year 1974 to $282 million in the year 1994. Berkshire has taken stake into the company in the year 1995.

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R.C. Willey Home Furnishings

R.C.Willey is the leading home furnishings business in Utah. Bill Child, CEO of R.C. Willey has taken over the business from his father-in-law in the year 1954 when sales were about $250,000 and he put efforts which resulted into the sales of $257 million in the year 1995. Company accounts for 50% of the furniture business in Utah.

According to Mr. Buffett, Retailing is a tough business –

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GEICO Corporation

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Mr. Buffett has bought GEICO into his personal account when he was at the age of 20 years.

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Float

Berkshire has not only compounded business earnings but also compounded its float. Since the year 1967 to the year 1995, Company has compounded its float by the compounded rate of 20.7%.

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Examples of the companies which generating 10%+ ROA and compounded float –

One of the automobile and commercial vehicle company which has created a huge wealth –

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One of the automobile company which has created a wealth –

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One of the FMCG Company which has created a huge wealth –

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One of the Asset Management Company –

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Charlie and Buffett believes to control being wrong and follow – “Just tell me the bad news; the good news will take care of itself”

Disney

The merger of Cap Cities into the Disney approved in the year 1995 where Cap Cities shareholders get a choice of cash or share of Disney (one share of Disney for one share of Cap Cities). Berkshire has selected share option for their 20 million of Cap Cities shares.

Mr. Buffett has been interested into the Disney since the year 1966 where Disney was available at ~23% of pre-tax earnings yield (23% = $21 million of pre-tax profit / $90 million of market value).

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