Berkshire: Part 2

Berkshire Graph

More commentary on the 2014 Berkshire Letter



Buffett is a Lucky Coin-flipper?

I enjoyed reading Berkshire -Past, Present and Future, pages 24-28 2014ltr

Mr. Buffett’s anger at Stanton’s chiseling cost dearly because he didn’t sell at the first puff of the “cigar-butt” (Berkshire’s Textile Division). Buffett suffered in a value trap.

Notably, Buffett’s cigar-butt strategy worked well when managing small sums–the best of Buffett’s life in terms of relative and absolute investment performance.  However, cigar-butt investing was not scalable or enduring with larger sums.  Buffett then turned towards buying wonderful businesses at fair prices or, in other words, franchises with honest and able management.

His investment in See’s Candies was a turning point because the company generated high returns on invested capital which Buffett could then redeploy into other businesses.  Note that See’s could only grow profitably within a defined region (Calif.?).  A powerful brand coupled with economies of scale makes for a great business.

Berkshire Today (page 29) provides a description of Conglomerates and the mania that occurred in the 1960s with ponzi-scheme pooling of interests accounting and ever-rising P/E multiples–until the game crashed.

Buffett points out the folly of spin-offs, whereby the owning company loses purported “control-value” without any compensating payment.  Investment bankers and private equity buccaneers were heartily savaged by Mr. Buffett’s pen.

Articles and Videos of Interest

25-old-investor-spurred-lumber  A short-sellers uncovers Lumber Liquidators.

shark-tank-the-speculators-guide-to-junior-mining-investment-session-1-with-rick-rule/  A series of talks on speculating in junior miners.

Back to Deep Value

Before we dig deeper into Chapter Five in Deep Value, I thought we should read Chapter 2 in Quantitative Value so as to not skip over several important points.  I will make sure new students receive a link to the books in the course.

2 responses to “Berkshire: Part 2

  1. Yes, what WEB wrote about conglomerates was very interesting.

    Just as some background:- The “pooling” method for consolidation accounting was used to aggregate the assets and liabilities of the purchaser and the target, without any goodwill being recognised. This was important (back in the old days) because goodwill was amortised in the P&L. This means that, if you could have the acquisition qualify for the pooling method, then your reported profits wouldn’t be reduced by amortisation charges. (I gather that another advantage of the pooling method was that it also allowed the purchaser to continue to use the target’s cost basis for assets, which was relevant for calculating depreciation and the like.)

    I remember going to a M&A meeting in the late 1980s at which a partner from one of the “Big 8” accounting firms was called in to advise on the proposed transaction. He cheerfully recommended that our client do X, Y & Z, so as to use the pooling method which would allow higher earnings to be reported going forward! It was certainly an eye-opening experience to see a supposedly independent auditor openly advocating how the rules could be gamed !

    These days, of course, goodwill is not amortised (except in the limited case of certain “indentifiable intangibles”) and, in any event, the acquisition method of consolidation accounting is mandated. (I’m talking about IFRS here – I suspect that US GAAP is roughly the same.)

    So what WEB wrote about the pooling method is no longer important.

  2. Agreed, but the psychology leading to the mania in conglomerates is the lesson to glean. Investors during the frenzy did not look through to the economics of the transactions. Not all dollars of earnings are equal depending upon the certainty and capital required to produce those earnings. Therefore, applying the same “multiple” is poor judgment.

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