of his acquisitions are occurring preciselywhen earnings are falling and the P/E ratio is skyrocketing higher. In chapter 11, I take the analysis one step further, and examine whether P/E ratiosare truly predictive of the future.What tools can be used, then, in helping predict future cash flows?• Growth of the U.S. economy. In general, if the U.S. economy growsat a certain percent a year, then the cash flows of the market are mostlikely growing at the same rate, give or take one to five percent. Themarket has grown slightly faster than the economy only becausethe multiple over those cash flows has grown slightly over the years. Ifstocks go up much faster than the U.S. economy, as happened in the1990s when the gross domestic product (GDP) was growing at approximately six percent a year and the Nasdaq was going up almost 30 percent a year, bad things can eventually happen.• Operating Margin, Return on Equity (ROE), or Return on Capital (ROC). A study by John Schmitz and Sean Cleary on what fundamental criteria have been the most predictive for stocks on the TorontoStock Exchange from 1989 to 1998 determined that return on equityand operating margin were consistently among the top factors forevery time period. The higher the ROE and operating margin, the morelikely a stock would go up in the next period.Return on equity is defined as the net profits of a firm divided by thetotal amount of equity invested in a firm. In our lemonade stand example, ifsomeone started with $15 ($10 for the table, $3 for the first set of cups, and$2 for the first batch of lemonade) and earned $10 in the first day, then theROE would be 66 percent. If the stand’s owner has a high operating margin
Equities
49
(gross profit over sales), then he or she would presumably need to reinvestrelatively little of the profits in order to sustain the current level of profitability. Companies with a high fixed asset base, where assets are depreciating and occasionally need to be replenished, will suffer severely if theoperating margin is hurt for any reason or if the business slows in general.Does this mean Buffett simply does a screen on all public equities andbuys companies with high ROEs and high operating margins? Absolutelynot. In some cases, Buffett bought companies that were experiencing declining earnings (The Washington Post is a good example), but Buffett believedin management and in the industry. In one case (Coca-Cola), Buffett boughta business that had suffered in the past. He wanted to capitalize on theturnaround despite the fact that the business was neither cheap, nor wasthere necessarily a catalyst that was going to drive up the stock price. Inanother case (GEICO), Buffett bought into a business that to all outwardappearances was completely falling apart, but he had a belief in the underlying fundamentals of both the business and the industry. The lesson wecan take from all this is that there is no one formula for success.
CHAPTER 4
CurrentHoldings
T
his chapter provides a list of Buffett’s current known holdings, alongwith some statistics and background about each one.
AUTOMATIC DATA PROCESSINGSymbol: ADP (NYSE)Date Purchased: 2003ADP is the world’s largest provider of outsourced payroll processingservices. Despite 10 years of steady revenue and earnings increases, thestock dipped in 2002–2003 during the general market decline. Buffett and/orBerkshire Hathaway started to accumulate the shares. He played it for thesmall dip and subsequent rise, and then got rid of the shares in the first halfof 2004.
DOVER CORPORATIONSymbol: DOV (NYSE)Date Purchased: 200151
52
TRADE LIKE WARREN BUFFETT
EXHIBIT 4.1
ADP
Year
Revenues
Net Income
Margin
Book/Share
ROE
4-Jun3-Jun2-Jun1-JunJun-00Jun-99Jun-98Jun-97Jun-96Jun-95
7399.571477004.37017.66287.55540.14798.14112.23566.62893.7
935.61018.21100.8924.7840.8696.8605.3513.5454.7394.8
12.614.215.713.213.412.612.612.512.713.6
NA$9.03$8.17$7.53$7.29$6.43$5.64$4.54$4.02$3.64
NA1921.519.718.317.417.819.319.618.8
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
Dover is a modern, behind-the-scenes conglomerate. Rarely mentioned inthe media, it makes everything from gasoline-pump nozzles to automatedprinted circuit board assemblers to tractor trailers. They have shown consistent revenue and earnings increases throughout the 1990s, both internally and through acquisitions. Buffett bought shares in the first quarter of2001 and kept adding to his position until early 2003, approximately aroundthe time that the stock bottomed. Paul Tudor Jones, one of the greatest
53
Current Holdings
traders ever, once stated, “losers average losers.” I think it is more a matterof “to each his own.” Buffett clearly likes to buy good companies that aregoing through hard times and then average down as the stocks becomecheaper. With Dover, Buffett had a company with so many years of consistent growth and earnings that he was confident, once the recession of2001–2002 was over, that it would return to its old form. As of the endof 2003, when Buffett started selling his shares, Dover’s book value wasthe highest it had ever been, even after the dip of 2002.
EXHIBIT 4.2
DOV
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
4413.34183.74459.75400.74446.43977.74547.74076.33745.93085.3
285.2211.1166.8533.2405.1326.4405.4390.2278.3202.4
6.553.79.99.18.28.99.67.46.6
$13.52$11.83$12.44$12.02$10.06$8.67$7.65$6.62$5.40$4.39
10.77.29.921.345.619.823.826.222.720.3
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
54
TRADE LIKE WARREN BUFFETT
AMERICAN EXPRESSSymbol: AXP (NYSE)Date Purchased: 1991American Express is the world’s largest issuer of charge cards and traveler’schecks. They also provide other financial services such as financial planning,investment advisory services, insurance, annuities, mutual funds, and so on.
EXHIBIT 4.3
AXP
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
25866238072258223675212781913217760162371584114282
3000267113112810247521411991190115641380
11.611.25.811.911.611.211.211.79.99.7
$11.93$10.62$9.04$8.81$7.52$7.14$6.84$6.01$5.53$4.19
19.619.310.92424.522.120.822.319.522.7
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
55
Current Holdings
AMERICAN STANDARDSymbol: ASD (NYSE)Another mega-conglomerate in Buffett’s holdings, American Standardmakes products ranging from kitchen equipment to air-conditioningsystems to bathroom fixtures. When Buffett was rolling up furniture companies and carpet companies, he was also probably assuming that the
EXHIBIT 4.4
ASD
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
8567.67795.47465.37598.47189.56653.96007.55804.65221.54457.5
405.2371295315.2264.133.6119.9–46.7141.8–77.7
4.74.844.13.70.52–0.82.7–1.7
$3.27$1.05($0.42)($1.88)($2.34)($3.34)($2.82)($1.61)($1.69)($4.36)
56.8161.4NANANANANANANANA
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
56
TRADE LIKE WARREN BUFFETT
housing bust would lead to more purchases in American Standard’s domain.He first purchased American Standard stock in 2002.
H&R BLOCKSymbol: HRB (NYSE)Date Purchased: 2001
EXHIBIT 4.5
HRB
Year
Revenues
Net Income
Margin
Book/Share
ROE
4-Apr3-Apr2-Apr1-AprApr-00Apr-99Apr-98Apr-97Apr-96Apr-95
3625.13295.22917.22810.32196.81498.61187.71805.7764.61233.8
704.3580.1434.4276.7251.9237.8174.247.8125.1107.3
19.417.614.99.811.515.914.72.616.48.7
$10.96$9.29$7.56$6.39$6.22$5.44$6.27$4.80$5.03$3.27
37.134.931.723.620.720.329.24.81715.6
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
Current Holdings
57
Death and taxes are here to stay, but I would add to that by saying, “Death,taxes, and shaving.” The purchase of H&R Block stock beginning in 2001reminds me of another, larger Berkshire holding with Gillette. Every day,a billion people or more around the world are shaving. Similarly, everyyear, hundreds of millions of people pay taxes and H&R Block has theintangible brand that people know they can trust for cheap, easy, andmoney-saving tax advice. The stock dipped in 2000 along with the generalmarket; Buffett, realizing that the fundamentals of the business had notchanged at all but that the market was suddenly giving away stock at acheaper price, began to buy.
COCA-COLASymbol: KO (NYSE)Date Purchased: 1988What can be said about this investment that hasn’t already been said?Robert Hagstrom’s summary of this investment, which appears in The Warren Buffett Way,1 is excellent. Despite the steady and consistent revenues,earnings, and ROE of the 1990s, this was initially a turnaround play thatBuffett bought at the tail end of the turnaround. In the 1970s, Coca-Colawas trying out new businesses from clothes to movies. Then, in the mid1980s, the installation of CEO Roberto Goizueta got the company back ontrack. It was definitely not a Graham-Dodd play in the classic sense,whereby a company is bought for less than its net tangible assets. However,this is where the influence of Charlie Munger played a role. Buffett made anestimation of how to value the intangible of Coca-Cola’s brand name. Ineffect, he was still trying to go the Graham-Dodd route but adding theintangible value of the brand name to the net tangible assets. How is it possible to determine the value of a brand name? To some extent, it can bedone by looking at return on equity.The beauty of capitalism is that money doesn’t grow on trees. If therewere such a tree, then everyone would instantly converge on that tree andpick all the money off until it were bare. High return on equity businessesare equivalent to such fictional trees—capitalism kicks in by provid-
1
The Warren Buffett Way, Robert Hagstrom, John Wiley & Sons, Inc., 1993.
58
TRADE LIKE WARREN BUFFETT
ing competition until the ROE decreases in response as margins go down. Themythology of the brand is what keeps entrepreneurs and potential competitors at bay and forces them to look toward other businesses and industries.Interestingly, the rise of water as a marketable product (paying $5 agallon for what you can get for free from your tap) is probably what hasslowed Coke down a bit around the world. Buffett has repeatedly said that
EXHIBIT 4.6
KO
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
21044195642009220458198051881318868185461801816172
4347397639792177243135334129349229862554
20.720.319.810.612.318.821.918.816.615.8
$5.77$4.78$4.57$3.75$3.85$3.41$2.96$2.48$2.15$2.05
30.933.73523.425.64256.556.755.448.8
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
Current Holdings
59
this is one of his permanent holdings. And at 34% ROE, it is not a bad placeto keep the billions Buffett has here. But he hasn’t added to his position ina while; my guess is that he won’t in the near future.
COSTCO WHOLESALESymbol: COST (NASDAQ)Date Purchased: 2000Buffett has always said that one of his biggest mistakes was not buyingWal-Mart. He thought the price was too high when he looked in the 1970sand kept waiting for the dip that never happened. When Munger encouraged Buffett to look at the Costco model (Munger is on the board ofCostco), Buffett may have seen it as his second chance. Munger has alwaysbeen a fan of the Costco model and said so at the Berkshire Hathaway 1999annual meeting: “I’m such an admirer of the Costco culture and the Costcosystem that I’m not sure I’m totally rational. I love the place. That isn’t sobad in life, to find a couple of things you love.”Costco is a great example of how Buffett approaches a stock purchase.He doesn’t simply say, “This is a great company; I need to buy it.” Buffettlikes to play the mean-reversion game. When bad news affects a stock,people have a tendency to react in a strong fashion, and that reactionusually turns into an overreaction. When Costco missed analysts’ earningsestimates by a penny on May 24, 2000, the stock fell 22%. At that pointBuffett must have examined the news and asked himself: Are people irrationally selling this stock, or is this news serious? Perhaps Costco wasgrowing too fast. Or maybe the margins were starting to get hit by increasedcompetition from ex-Buffett mistake Sam’s Club (owned by Wal-Mart).We don’t know for sure what Buffett looked at between May 24, 2000,when the shares sold off and September 30, 2000, by which point he hadaccumulated 24 million shares of the company. But presumably he wantedto see that the high-margin items (pharmacy, one-hour photo centers, optical) were still doing well. He probably wanted to make sure that management was still just as tight on their cost controls as they had always been.He definitely would have examined their inventory turnover to make surethey were still selling goods as quickly as before. Once he found a comfortlevel that the general market was being too aggressive on the sell side, he
60
TRADE LIKE WARREN BUFFETT
EXHIBIT 4.7
COST
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Aug2-Aug1-AugAug-00Aug-99Aug-98Aug-97Aug-96Aug-95Aug-94
42545.638762.53479732164.32745624269.921874.419566.517905.916480.6
721700602.1631.4515.3459.8312.2248.8217.2110.9
1.71.81.721.91.91.41.31.20.7
$14.34$12.51$10.92$9.48$7.98$6.82$5.78$4.53$3.92$3.87
1112.312.314.914.615.512.61414.24.2
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
began buying. Although we don’t know his average cost, it was probablysomewhat near where it was after the 2000 sell-off: in the low $30s. Currently the stock is slightly above $40.
FIRST DATA CORPORATIONSymbol: FDC (NYSE)Date Purchased: 2002
61
Current Holdings
First Data Corp. does credit card transaction processing for over 3 millionmerchants around the world. First Data also owns Western Union. Steadyrevenue growth in the 1990s was not enough to fight off the market contraction that occurred in mid-1998, and Buffett began to buy. He boughtmore in late 2002 when the stock dipped despite increases in revenues,earnings, and return on equity.
EXHIBIT 4.8
FDC
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
8400.27636.26450.85705.25539.85117.64978.54934.14081.21652.2
13941237.9874.6929.61199.7465.7356.7636.5–84.2208.1
16.616.213.616.321.79.17.212.9–2.112.6
$5.65$5.52$4.63$4.74$4.68$4.31$4.09$4.14$3.52$2.30
34.829.824.824.930.712.49.817.2NA20.5
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
62
TRADE LIKE WARREN BUFFETT
GANNETT CO. INC.Symbol: GCI (NYSE)Date Purchased: 1994Gannet is the publisher of USA Today and others news publications. This isanother of Buffett’s permanent holdings and there are countless case studies of the investment, including ones in Robert Hagstrom’s books, MaryBuffett’s books, and of course, Andy Kilpatrick’s Of Permanent Value.
EXHIBIT 4.9
GCI
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
6711.16422.26344.26222.35260.25121.34729.54421.14006.73824.5
1211.21160.1831.2971.9919.4999.9712.7624477.3465.4
1818.113.115.617.519.515.114.111.912.2
$30.92$25.80$21.58$19.31$16.66$14.26$12.26$10.37$7.63$6.52
14.416.814.519.120.725.120.532.222.225.5
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
63
Current Holdings
GAP INCORPORATEDSymbol: GPS (NYSE)Date Purchased: 2000The Gap started having trouble in 2000 when decreased consumer spending, heavy expansion costs, and lower margins started affecting both profits and the stock price. The company had been making record revenues,
EXHIBIT 4.10
GPS
Year
Revenues
Net Income
Margin
Book/Share
ROE
4-Jan3-Jan2-Jan1-JanJan-00Jan-99Jan-98Jan-97Jan-96Jan-95
1585414454.713847.913673.511635.49054.56507.85284.44395.33722.9
1030477.5–7.8877.51127.1824.5533.9452.9354320.2
6.53.3–0.16.49.79.18.28.68.18.6
$5.33$4.12$3.48$3.43$2.63$1.84$1.79$1.79$1.69$1.41
21.513.1NA3050.552.433.727.421.623.3
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
64
TRADE LIKE WARREN BUFFETT
profits, and increases in same-store sales right up until 2000–2001. The factthat they had had a non–record-breaking year shouldn’t be consideredearth-shattering, and yet that is exactly how the market treated it. Buffettwas perhaps impressed by its prior consistency and assumed that thestrength of its brand, backed up by its prior high ROE would help the company stage a comeback. It proceeded to do exactly that by 2003 when itsmargins and ROE doubled and the book value reached a record high. Buffett began accumulating in 2000, continued his accumulation all through2001 when the Gap was going through the worst of its troubles, and finallybegan selling in late 2003 when the shares began to rebound.
GILLETTE CO.Symbol: G (NYSE)Date Purchased: 1989As will be covered more extensively in Chapter 7 on PIPEs, Buffett initiallybought Gillette as a convertible preferred issue directly from the companywhere he was being paid a nine percent coupon. He later converted hisholdings into common equity and has held for the duration.
HCA INC.Symbol: HCA (NYSE)Date Purchased: 2003HCA is a hospital chain based in Nashville, Tennessee, owning almost 200hospitals and over-80 surgery centers. When Berkshire’s GEICO unit (wherethe investment decisions are made by Lou Simpson, Buffett’s current #2 onthe investment side of Berkshire Hathaway) began buying up shares ofHCA in 2003, the hospital chain had just reported a 31% decline in profits.Again, Buffett/Berkshire rarely buys companies where the earnings are100% consistent. No company, unless it is managing its earnings, is consistent forever. However, the market always makes the assumption that companies should and will have consistent earnings. Buffett, Simpson, Munger,Berkshire, and GEICO all wait for the usual earnings shortfall, the typicalmarket overreaction (see the straight line in the HCA chart that occurred inmid-2003). Then they begin buying after thorough due diligence.
65
Current Holdings
EXHIBIT 4.11
G
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-98Dec-97Dec-96Dec-95Dec-94
9252845389619295989710056100629697.76794.76070.2
13751209910821126010811427948.7823.5698.3
14.914.310.28.812.710.714.29.812.111.5
$2.21$2.16$2.02$1.83$2.80$4.04$4.25$3.98$2.76$2.22
62.353.842.620.442.324.229.921.533.635.6
Source: Reproduced with permission of Yahoo! Inc. © 2004 by Yahoo! Inc. YAHOO!and the YAHOO! logo are trademarks of Yahoo! Inc.
In this case, the due diligence had to examine what had caused theearnings shortfall. Would it occur again? Specifically, in mid-2003, the company announced that the information system it had put together for the purpose of keeping track of its account receivables was not working too well.They dropped the system, taking a charge of $130 million, or 15 cents pershare. They also increased their reserves for questionable receivables by$106 million, or 13 cents per share.
66
TRADE LIKE WARREN BUFFETT
One factor that helped Buffett in his due diligence was that HCA hadbeen in an accounting scandal before and had only a year earlier settledwith the Department of Justice involving claims that they had overchargedthe Medicare system. Part of the settlement involved the company’s hiringauditing firms to conduct regular company-wide audits. The scandal alsobrought back prior CEO Tom Frist and his second-in-command, now CEO,Jack Bovende, who helped restore corporate governance and fiscal sanity
EXHIBIT 4.12
HCA
Year
Revenues
Net Income
Margin
Book/Share
ROE
3-Dec2-Dec1-DecDec-00Dec-99Dec-