Between 1965-2008, the book value of Berkshire Hathaway shares grew at compounded annual gain of 20.3%.  In comparison, the S&P 500 (including dividends) had a compounded annual gain of 8.9%.

Regarding the current economic environment, Warren Buffet notes:

But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.

An individual investor can follow Buffet’s lead by ensuring that his or her portfolio contains companies with strong balance sheets, proven management, solid earnings, strong market share, and a wide moat.  Historically, companies of this type have sold for a substantial premium (i.e., a higher P/E than their peers).  However, the market decline has reduced that premium.  This is a good time to exchange low or medium quality companies for high quality one.

]]> http://stockherd.com/moosepond/2009/03/taking-a-long-term-view/feed/ 0 http://stockherd.com/moosepond/2008/11/replacing-low-par-stocks/ http://stockherd.com/moosepond/2008/11/replacing-low-par-stocks/#comments Sat, 01 Nov 2008 21:00:23 +0000 Admin http://stockherd.com/moosepond/?p=312 Using data from our portfolio dashboard on Manifest Infesting, here are some proposed changes to the portfolio.

First, sort the portfolio by projected average return (PAR) to show which stocks have the highest and lowest PAR. You do this by clicking on the PAR column heading or look at this PDF file.  (Place your mouse over the embedded yellow note in the PDF file.)

The six stocks on the bottom (highlighted in yellow in the PDF file) have the lowest projected average return. Looking at these stocks, that is not surprising. Two are bank stocks (WFC and SNV). The current housing market adversely impacts LOW.  Similarly, a decrease in consumer spending impacts BBBY and WMT.

We should consider replacing all of these except JNJ. (JNJ is a high quality blue chip stock despite the mediocre PAR.  It is a keeper.)

Now we can add to our positions in stocks we already own with stocks that have a higher projected average return than those we are replacing.

Look at again at our portfolio dashboard. Now sort by the value this time, so our largest positions are on top and our smallest positions are on the bottom. Look for stocks for which we don’t yet have a 5% position and which have a projected average return of more than 20%. We can would increase our position in those shares to about 5% or $2,000 total.

This PDF file shows the idea. The candidates for replacement are shown with struck through text. These are the five stocks with the lowest projected average return or PAR. The candidates for additional shares are highlighted in yellow.

There are several additional stocks we may want to consider, including ADBE, AAPL, PCP, and PTR. More to follow on this.

Using the performance benchmark report in Bivio, the internal rate of return for the Moose Pond portfolio was a negative 27.6% year-to-date on October 31.  In comparison, the Vanguard Total Market Index Fund was down 38.6% and the Vanguard S&P 500 index Fund was down 38.5% for the same 10-month period.

It will take a strong post-election rally to take the edge off the losses for this year.  Stock valuations are at a low for several decades.  So while there has to be pony in here somewhere, no one can be sure exactly when we’ll find it. In the interim, we should continue to follow out investment objectives and remain fully invested and commit new cash.

We do have an opportunity to replace several of our stocks with ones that have a higher projected average for the next five years.  More to follow on that.

Here are performance reports for the one month and 12 month periods ending on October 31, 2008.

AIG was the big loser, dropping 93%.  The stock is probably a lost cause.  Good thing we didn’t but any more!  The other contributors to our losses this year were Synovus Financial (-50.8%), Total System Services (-35.2%), Microsoft -28.5%), and Intel (-26.5%).

An astute reader of this blog pointed out that most of the drop in price for Synovus Financial (-50.8%) this year was a result of the spin-off of TSS in January.  That’s exactly correct.  Just looking at the price of SNV does not tell the whole story.   At the beginning of the year, our holdings in SNV had a value of $1,758.  SNV and TSS currently have a combined value of $1,392.  So the actual decline in value this year is only 20.8%.

But for the losses on AIG and TSS, we would have been in positive territory for 2008.

We do have some winners this year.  They include Helmerich & Payne (+40.3). Wells Fargo & Co. (+36.2%), Amgen (+29.1%), Sun Hydraulics (+26.4%), and Lowes (+26.3%).  This underscores the importance of diversification and quality in a portfolio.

Take a look at the portfolio dashboard from Manifest Investing.  We may want to consider selling Bed, Bath & Beyond and Brown & Brown.  At the same time, we may want to slightly increase our holdings in Microsoft, Walgreen, Transoceanic, and FactSet Research.  Each of these companies have a high quality rating and high projected average return.

Sun Hydraulics Corp., SNHY, reported Q2 (June) earnings of $0.54 per share, $0.04 better than the First Call consensus of $0.50.  Quarterly revenues rose 18.8% year over year to $51.6M vs. the $51.4M analyst consensus.  (Q3 earnings press release.)

However, the company reduced its outlook for Q3, projecting EPS of $0.35-0.37 which is slightly lower than the $0.42 analyst consensus.  The company also projected Q3 revenues of $45M which is slightly lower than $47.93M analysis consensus.  Here is the company’s statement regarding Q3.

“Sun’s products are used in diversified equipment markets around the globe,” stated Carlson. “Many of these markets, such as mining and energy, remain strong and demand is high.  In other more obvious markets, such as equipment used in residential and commercial construction, we have begun to see some softening.”

“The diversity of our end markets, both geographically and the segments we participate in, is pivotal to maintaining our growth,” concluded Carlson.

2008 third quarter sales are estimated to be approximately $45 million, a 9% increase over last year. Third quarter earnings per share are estimated to be between $0.35 and $0.37 per share, compared to $0.32 per share last year.  EPS estimates for the third quarter include a charge of $775K for U.S. income taxes due on the repatriation of $6 million from Sun Germany in July 2008.

This slightly reduced guidance caused the stock to drop 11.24% on August 5 after it announced its earnings.

Here is an updated stock selection guide that incorporates the Q3 data.  It use a conservative estimated of 18% for revenue and sales growth.  It also uses a conservative 5-year average average P/E of 16.9.  The SSG still shows a projected average return of 13.7%.  The fundamental business model of the company has not changed.  It is still a strong hold.  Despite teh drop in price yesterday, we have a 17.2% annualized return on SNHY.

• 15.372 additional shares of Garmin Ltd. (GRMN) at  $45.34
• 39.416 additional shares of Lowe’s Companies Inc (LOW) at $20.22
• 11.974 initial shares of Transocean Inc. (RIG) at $133.62

We sold 27 shares of Helmerich & Payne Inc (HP), a gas and drilling company, at $57.27 reducing the weight of this holding to 2.9%.  Transocean, a deep sea oil and gas drilling company,

On July 30, we purchased an additional 15.682 shares of Garmin at $39.250.  Garmin took quite a beating last week when it reduced its 2008 earnings guidance from $4.40 to $4.13 per share.  Garmin also reduced its revenue guidance from $4.5 billion to $3.9 billion.  It appears that the bad news is more than reflected in the current stock price of $33.64.

A stock selection guide (SSG) for Garmin can be found here.  This SSG assumes a reduced revenue growth of 12% and a reduced pre-tax profit marin in five years.  The SSG assumes a future P/E of 15 (current P/E is 8).  The projected average return is 23.1%.

It might be wise to diversify and include deep water drilling company.  Transocean Inc. (RIG) pops up in numerous screens and articles. Value Line describes Transocean as the world’s largest offshore drilling contractor, working in all the major offshore regions, including the Gulf of Mexico, the North Sea, the Middle East, and off the coasts of West Africa, the United Kingdom, Norway, Brazil, and Canada.  It specializes in technically demanding deep-water/harsh-environment drilling projects.

Here is a stock selection guide for Transocean.  Manifest Investing estimates a projected average return of 19.3%.  Morningstar rates Transocean 5-stars (undervalued) and calculates fair vale as $176 (current price is $133).  We should consider selling part of our position in HP and buying RIG.

Maxim got caught up in an options backdating scandal.  Nasdaq delisted it.  And it has taken the company a long time to restate its financials, which has resulted in significant legal and accounting fees.

Barron’s reports today:

Now there are signs that the worst may be over. The company, with a market value of $6 billion, has submitted revised financial statements to its auditors. Earnings are expected to pick up next year, as the legal expenses of the probe recede into the past. And conditions in the chip industry could start to improve markedly within a couple of years.

Result: The stock could rocket by more than 40%. The hope is that growth investors, who abandoned the shares over the past couple of years, will start returning in force. What they’ll find is a stock that trades at a sharp discount to its peers and boasts $1.2 billion of cash and no debt.

Value Line stopped covering Maxim when it was delisted.  However, Morningstar still follows the company and rates it 5-stars (undervalued) and gives it a fair value estimate of $34.  Here are some excerpts from the Morningstar Report from May:

We consider Maxim Integrated Products one of the better long-term semiconductor investments. With attractive products, sought-after talent, and a plausible plan for growth, Maxim should continue generating healthy returns on invested capital for many years. …  Maxim is well positioned in its core business of high-performance analog (HPA) chips, which are complex and proprietary by nature. Armed with one of the most talented design teams in the industry, Maxim has been able to produce superior designs that command a price premium. … We now expect Maxim to grow sales at a compound annual rate of 8.2% for the next seven years, down from the 13% assumption used in our previous model. Although we expect the consumer business to be highly competitive, we think Maxim’s gross margins will likely remain in the low 60s. … We forecast operating margins in the low 30s.

Until the SEC approves its revised financial statements, Maxim is limited on the information it may release publicly.  This makes analysis of the company difficult.

Maxim will release financial results for the fourth quarter of its 2008 fiscal year on Thursday, August 7, 2008.  A video replay of the earnigns conference can be found on the investors section of the Maxim website.

Looking across the Moose Pond portfolio, we see a few stocks that warrant a close look.

• Helmerich & Payne has a PAR of 5.7%.  This oil field services company has had a good run and is up 78% since we purchased it last June. It is 6.2% of the portfolio.  We could take a small profit and sell some of this stock.
• Brown & Brown has been a relatively unexciting holding.  We purchased in March 2004. It is down 10% and represents about 1.4% of the portfolio. We might want to consider replacing it.
• AIG has been the worst performer in the portfolio (and a good example of why diversification is so important).  It is down 64% since we bought it last June.  This is one of those financial stocks that will turn when the financial sector finally does.  At some point we may want to add to our AIG holding, if we don’t purchase Berkshire Hathaway.
• We might want to increase our position on few sticks with high PARs, Lowes (21.6%) and Garmin 26.7%.  Lowes is 2.5% of our portfolio and Garmin is 1.4%.

Take a close look at the portfolio dashboard and the portfolio valuation report at Bivio.com.  We need to make some adjustments to our portfolio.

In 2007, Berkshire Hathaway’s annual revenues totaled $118B.  To put their businesses in perspective, insurance premiums were $31.8B while sales and services revenue from the non-insurance businesses was $58.2B. So calling Berkshire an insurance company is not very accurate, but insurance is one of its core businesses.

At the end of 2007, assets for the various Berkshire insurance companies included $39.8B in cash and $86.8B in equities and fixed maturity instruments.  These assets include reserves for anticipated covered losses. For the non-insurance businesses, cash and fixed maturity instruments totaled $8.8B. Together, these assets give Berkshire the ability to internally finance its operations.  It provides the cash to acquire new businesses.  This cash also gives Berkshire the ability to add substantial positions to its investment portfolio.

The breadth of Berkshire’s business and investment holdings make it difficult for analysts to perform cash flow analysis and to estimate earnings.  As you can see from the attached file, the Value Line assessment differs from that of Morningstar.  (Morningstar appears to be more on the mark although they don’t do a good job explaining their discounted cash flow analysis.)

Warren Buffet and Charlie Munger have managed Berkshire Hathaway form the beginning in 1964. Integrity, honesty, and business acumen have been the hallmarks of their stewardship over the past 43 years.  They have set the gold standard for corporate openness and transparency. Their results are unmatched.  Share prices have compounded at rate of 21.1% between 1964-2007.   The sheer size of Berkshire Hathaway today will probably prevent it from achieving this high rate of return in the future. Nonetheless, Berkshire shareholders can expect to do well.

Warren Buffet’s annual letters to shareholders can be found here.  They should be mandatory reading for every investor.

Morningstar rates Berkshire Hathaway five-stars with a fair market value of $5,100 (for the class B shares, BRK.B).  Current price as of this posting is $3,914.  Manifest Investing estimates projected average return of 17.5%.  Here is a completed stock selection guide for Berkshire Hathaway.

Note:  Berkshire Hathaway has two classes of shares.  The “B” share ($3,914) is valued at 1/30 of the “A” share ($117,290).  Berkshire Hathaway has never paid a dividend or authorized a stock split, so the 21.1% compound annual growth is reflected in the high price of the stock.

Berkshire Hathaway is an excellent core holding.  We should consider purchasing purchasing one of the “B” shares with our available cash.