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Archive for September, 2006

Recently, Buffett paid $4 billion to buy 80% of the shareholdings in Iscar. An one-hour tour of the Tefen plant was enough to satisfy him that it was the right thing to do.

My partner Charlie and I had the opportunity to see magic with our own eyes during our visit to Iscar,” Buffett said. He added, “We’ve seen thousands of companies and have never seen such a combination of enormous achievement, power, talent and imagination as we saw at Iscar, a company that grew out of nothing to become a supplier to international companies.

He was so convinced of what he saw that he’s now prepared to look at additional investments in Israel.

Here are 3 video clips (total 43 minutes) of the media briefing with lots of sharing by Buffett.

The entire site is in Hebrew; to see the videos, just click on the pictures with Buffett’s photos. You need to wait a couple of minutes for the Hebrew commentary to finish before you can hear Buffett speaking in English.

You need to quickly go and watch it now as the photos will not appear on the front page after a few days. Once they are no longer there, you will need to navigate the site to find them. Which will be a challenge unless you know Hebrew.

High Growth Rate

If the base from which the growth is measured is small, it may still last a long time. But once it becomes big, it will eventually stop.

This phenomenal is aptly described by Carl Sagan, refering to the destiny of bacteria that reproduce by dividing into two every 15 minutes. Says Sagan:

That means four doublings an hour, and 96 doublings a day. Although a bacterium weighs only about a trillionth of a gram, its descendants, after a day of wild asexual abandon, will collectively weigh as much as a mountain…in two days, more than the sun – and before very long, everything in the universe will be made of bacteria.

Not to worry, says Sagan: Some obstacle always impedes this kind of exponential growth. “The bugs run out of food, or they poison each other, or they are shy about reproducing in public.

From Berkshire’s base of $4.9 billion in net worth, it will be much more difficult to average 15% annual growth in book value than they did to average 23.8% from the $22 million they began with.


A new accounting rule likely to be adopted will require companies to reserve against all gains at the current tax rate, whatever it may be.

In economic terms, the liability, equivalent to a transfer tax, resembles an interest-free loan from the U.S. Treasury that comes due only when the asset is sold.

Because of the way the tax law works, the Rip Van Winkle style of investing that Buffett favours, is much favourable than a short holding period of securities.

Suppose there is an investment that is bought at $1 and doubles in value. Each year, it is sold and the proceeds used to purchase another security which then doubles in value after another year.

At the end of 20 years, the 34% capital gains tax that is paid on the profits from each sale would have delivered about $13,000 to the government and $25,250 to the investor.

However, if there is a fantastic investment that itself doubled 20 times during the 20 years, its final value would grow to $1,048,576. If it were then sold, there would be a 34% tax of roughly $356,500 and the investor would be left with about $692,000.

The sole reason for this difference in results would be the timing of tax payments. Deferred taxaxtion is great!

Undistributed Earnings

In 1989 Berkshire recieved about $45 million, after taxes in dividends from their five major investees. However, their share of the retained earnings of these investees totaled about $212 million, not counting large capital gains realized by GEICO and Coca-Cola.

Are these undistributed earnings as important as those that were reported?

Buffett believes so. His reasoning is that earnings retained by these investees will be deployed by talented, owner-oriented managers who sometimes have better uses for these funds in their own businesses than in Berkshire.

Thus, a better gauge of Berkshire’s fundamental earning power is by using a “look-through” approach, in which the share of the operating earnings retained by Berkshire’s investees are appended to their own reported operating earnings, excluding capital gains in both instances.


There is a story related by Buffett about Ike Friedman. It has nothing to do with investments but it’s so humourous that I’m reproducing it below for your reading pleasure:

A story will illustrate why I enjoy Ike so much: Every two years I’m part of an informal group that gathers to have fun and explore a few subjects. Last September, meeting at Bishop’s Lodge in Santa Fe, we asked Ike, his wife Roz, and his son Alan to come by and educate us on jewels and the jewelry business.

Ike decided to dazzle the group, so he brought from Omaha about $20 million of particularly fancy merchandise. I was somewhat apprehensive – Bishop’s Lodge is no Fort Knox – and I mentioned my concern to Ike at our opening party the evening before his presentation. Ike took me aside. “See that safe?” he said. “This afternoon we changed the combination and now even the hotel management doesn’t know what it is.” I breathed easier. Ike went on: “See those two big fellows with guns on their hips? They’ll be guarding the safe all night.” I now was ready to rejoin the party. But Ike leaned closer: “And besides, Warren,” he confided, “the jewels aren’t in the safe.”

Buffett offers the following insights for the continued success of Borsheim and Nebraska Furniture Mart:

(1) unparalleled depth and breadth of merchandise at one location
(2) the lowest operating costs in the business
(3) the shrewdest of buying, made possible in part by the huge volumes purchased
(4) gross margins, and therefore prices, far below competitors
(5) friendly personalized service with family members on hand at all times

These are useful factors to consider when evaluating investments in retail businesses.

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Of CEOs and their soldiers…

Some CEOs clearly do not belong in their jobs; yet their positions are usually quite secure. The irony is that it is easier for an inadequte CEO to keep than it is for an inadequate subordinate.

If a secretary is hired for a job that requires typing ability of at least 80 words a minute and turns out to be capable of only 50 words a minute, she will lose her job in no time. Similarly for sales people that fail to meet their quota.

However, a CEO who doesn’t perform frequently stays on in his role, at least for some time. One reason is that performance standards for his job seldom exist. When they exists, they are usually fuzzy and any shortfall is usually waived or explained away.

At many companies, the bullseye is painted around the spot where the arrow lands.

Another important, but seldom recognized, distinction between the boss and the foot soldier is that the CEO has no immediate superior whose performance is itself getting measured.

It is in the immediate self-interest of a manager to weed out any under- performers in his team. But the CEO’s boss is a Board of Directors that seldom measures itself and is infrequently held to account for substandard corporate performance.

Bearing the above points, they should not be interpreted as a blanket condemnation of CEOs or Boards of Directors: Most are able and hard- working, and a number are truly outstanding.

Holding Period of Securities

When Buffett own portions of outstanding businesses with outstanding managements, his favorite holding period is forever. This is just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint.

Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.

Long Term Bonds

Buffett continues to hold his aversion towards long-term bonds. That will change only if prospects for long-term stability in the purchasing power of money improves. And that kind of stability is unlikely: Both society and elected officials simply have too many higher-ranking priorities that conflict with purchasing-power stability.


The word abitrage used to mean the simultaneous purchase and sale of securities or foreign exchange in two different markets. The goal was to exploit tiny price differentials that might exist between, say, Royal Dutch stock trading in guilders in Amsterdam, pounds in London, and dollars in New York.

Since World War I the definition of arbitrage – or “risk arbitrage”, has expanded to include the pursuit of profits from an announced corporate event such as sale of the company, merger, recapitalization, reorganization, liquidation, self-tender, etc. In most cases the arbitrageur expects to profit regardless of the behavior of the stock market.

The major risk he usually faces instead is that the announced event won’t happen.

To evaluate arbitrage situations you must answer four questions: (1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire – a competing takeover bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

Berkshire’s arbitrage activities differ from those of many arbitrageurs. First, they participate in only a few, and usually very large, transactions each year. Most practitioners buy into a great many deals perhaps 50 or more per year. Warren Buffett certainly does not want to spend all his time monitoring the progress of so many deals and the market movement of the related stocks!

The other way is that they participate only in transactions that have been publicly announced. No trading on rumors or trying to guess takeover candidates.

Efficient Market Theory (EMT)

The EMT said that analyzing stocks was useless because all public information about them was appropriately reflected in their prices.

While they observed correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient.

In Buffett’s opinion, the continuous 63-year arbitrage experience of Graham-Newman Corp, Buffett Partnership and Berkshire illustrates just how foolish EMT is. Returns have averaged 20% per year compared to the average market returns of 10% per year. That is a significant statistical difference.

All this said, a warning is appropriate. Arbitrage is not a form of investing that guarantees profits of 20% a year or, for that matter, profits of any kind. As noted, the market is reasonably efficient much of the time: For every arbitrage opportunity that Buffet seized in that 63-year period, many more were foregone because they seemed properly-priced.

An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style. He can earn them only by carefully evaluating facts and continuously exercising discipline. Investing in arbitrage situations, per se, is no better a strategy than selecting a portfolio by throwing darts.

Listing of Berkshire

Berkshire’s shares were listed on the New York Stock Exchange on November 29, 1988. Berkshire’s goals differ somewhat from most other listed companies.

First, they do not want to maximize the price at which Berkshire shares trade. Rather, they wish for them to trade in a narrow range centered at intrinsic business value.

Significant overvaluation as significant undervaluation will inevitably produce results for many shareholders that will differ sharply from Berkshire’s business

If the stock price instead consistently mirrors business value, each shareholder will receive an investment result that roughly parallels the business results of Berkshire during his holding period.

Second, they wish for very little trading activity. Their goal is to attract long- term owners who, at the time of purchase, have no timetable or price target for sale but plan instead to stay with them indefinitely.

Lots of stock activity can be achieved only if many of the owners are constantly exiting. At what other organization – school, club, church, etc. – do leaders cheer when members leave?

Of course, some Berkshire owners will need or want to sell from time to time, and there needs to exists good replacements who will pay them a fair price. Therefore they will try to attract new shareholders who understand their operations and share their time horizons.

If they can continue to attract this sort of shareholder – and, just as important, can continue to be uninteresting to those with short-term or unrealistic expectations – Berkshire shares should consistently sell at prices reasonably related to business value.

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Generally Accepted Accounting Principles (GAAP)

When an investor looks at financial statements, there are a few questions that he wants to know:

(1) Approximately how much is this company worth?
(2) What is the likelihood that it can meet its future obligations?
(3) How good a job are its managers doing, given the hand they have been dealt?

In most cases, answers to one or more of these questions are difficult from the minimum GAAP presentation.

Further complicating the problem is the fact that many managements view GAAP not as a standard to be met, but as an obstacle to overcome.

Then there are managers who actively use GAAP to deceive and defraud.

I just read a book on “understanding financial statements for managers” the other day and indeed it is easy to “cook” the books as a lot of accounting is subjected to the interpretation of the accountant.

If the information presented is insufficient, it then falls on the investor to ask the management to provide data (whether GAAP, non-GAAP or extra-GAAP) that helps us to answer the three questions above.

Update on major non-insurance business operations

There follows the usual summary of the major non-insurance business operations. These included Nebraska Furniture Mart, The Buffalo News, See’s Candies, Fechheimer, World Book, Kirby, The Scott Fetzer Manufacturing Group and Borsheim’s.

A very interesting fact was that when Warren purchased Borsheim’s, they had no audited financial statement and he didn’t take inventory, verify receivables or audit the operation in any way.

A lot of it was based on trust in the Friedman family, who were siblings of Mrs Blumkins (founder of Nebraska Furniture).

And the Friedman family brings to the jewelry business precisely the same approach that the Blumkins bring to the furniture business. The cornerstone for both enterprises is Mrs. B’s creed: “Sell cheap and tell the truth.” Other fundamentals at both businesses are:

(1) Single store operations featuring huge inventories that provide customers with an enormous selection across all price ranges.
(2) Daily attention to detail by top management.
(3) Rapid turnover.
(4) Shrewd buying.
(5) Incredibly low expenses.

The combination of the last three factors lets both stores offer everyday prices that no one in the country comes close to matching.

And Warren’s major contribution? Leave them alone and let them do their job.

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