Investing Ideas

The news
On April 22 CNBC reported that Warren Buffett is going to Europe to look at businesses. Buffett told CNBC

“My goal is to get on the radar screen of large family-owned companies in Europe, that for one reason or another, need an ownership change, but want the business to be run as it was under the family.”

In the US Berkshire Hathaway has a reputation of buying companies to hold for life. Berkshire Hathaway will always retain ownership of its subsidiaries and unless a company is in an industry where they will keep making losses in perpetuity the company will not be shut down. Berkshire lets a company run the way the founder used to run it. For this reason a lot of owners of private companies in the US have entrusted their lifes work to Berkshire. Since the founders are more interested in the welfare of their employees, the happiness of their customers and preserving their legacy they will typically sell only to Berkshire Hathaway and will do so at a fair price or even a discount to what they would get in the market. After the purchase of ISCAR metalworking, a company based in Israel, Buffett has realized there are wonderful companies all over the world that he could buy if Berkshire Hathaway and its culture was better known outside the US.

The search
I went through the Forbes Billionares list and selected these companies based on the following criteria

1. Company is based in Europe - Obvious since Buffett is visiting Europe
2. Company is not listed or is majority owned - Buffett is looking for family owned businesses
3. The current owner is older than 70 - Someone who wants to preserve his life work.
4. Net worth of the owner is greater than 2.5 Billion - This makes the business large enough to be interesting for Berkshire.
5. Excluded companies which only own investments and/or real estate holdings.
6. Excluded industries which Buffett has said he sees no future in or does not understand, eg:Newspapers, Publishing, Biotechnology

The age of 70 and net worth of 3 Billion are somewhat random numbers I pulled out of my hat to narrow the search. There could be smaller companies or companies run by younger individuals who might be on Buffetts radar.

The Candidates
The companies based on my criteria are listed below. The companies in bold are the ones I feel Warren Buffett might be most interested in.

• Ikea a Furniture Retailer owned by Ingvar Kampard (81)
• Aldi a grocery Retailer owned by Karl Albrecht (88) and Theo Albrecht(85)
• L’Oreal the world’s largest Beauty Products company owned by Lilane Bettencourt(85)
• Tetra Laval a packaging business owned by Birgit Rausing & family(84)
• Ferrero SpA a Food business owned by Michele Ferrero & family(81)
• Dassault an Aviation business owned by Serge Dassault & family(82)
• Bertelsmann a Media business owned by Reinhard Mohn & family(86)
• Wurth Group a Fastners business owned by Reinhold Wurth(72)
• Corticeira Amorim the worlds largest cork company owned by Americo Amorim(73)
• Tengelmann Group a retail trade business owned by Erivan Haub & family (76)
• Deichmann-Schuhe GmbH a shoe retailer owned by Heinz-Horst Deichmann
• Helm AG a Chemicals company owned by Hermann Schnabel(86)

Disclosure : I own shares of Berkshire Hathaway

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Berkshire Hathaway will release its Annual Report tomorrow after the close of trading. In my Opinion it is recommended reading for anyone that invests. The First 20-25 pages of the Annual Report are the Chairmans letter to Berkshire Hathaway shareholders. This is where you get a view into the mind of Warren Buffett, his views, opinions and take on the market. Here is a small excerpt which warned about the housing mess that unfolded a last year.

“The slowdown in residential real estate activity stems in part from the weakened lending practices
of recent years. The “optional” contracts and “teaser” rates that have been popular have allowed borrowers
to make payments in the early years of their mortgages that fall far short of covering normal interest costs.
Naturally, there are few defaults when virtually nothing is required of a borrower. As a cynic has said, “A
rolling loan gathers no loss.” But payments not made add to principal, and borrowers who can’t afford
normal monthly payments early on are hit later with above-normal monthly obligations. This is the Scarlett
O’Hara scenario: “I’ll think about that tomorrow.” For many home owners, “tomorrow” has now arrived.
Consequently there is a huge overhang of offerings in several of HomeServices’ markets.”

- Warren Buffett in the 2006 Charimans Letter to Berkshire Shareholders.

Berkshire is one of the most diverse companies in the US. It has operations in Insurance, Manufacturing, Housing, Retail, Utilities and more. Reading the financial details of each segment along with Buffets commentary usually provides valuable insight into the industries and the economy.

What should shareholders look for?
If you’re a shareholder of Berkshire Hathaway there is a lot to look for in the Annual Report. Here’s a small list

• Berkshire Hathaway Assurance Corp and Insuring Muni Bonds.
• The Marmon purchase.
• TXU Bonds.
• What Buffett likes about Kraft (KFT)?
• More details on last years teaser Burlington Northern (BNI).
• How the Insurance sector is performing?
• How last years 2 big acquisitions TTI and Equitas are performing?
• Is Buffett still invested in the Brazilian Real?
• and finally the most important thing to look for, how is the search going for investment managers to replace Warren Buffett?

I will be dissecting the Annual report in posts this weekend.

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Last weeks big whale news was Warren Buffett bought 8.6 percent of Kraft.

Why now?
Buffett needs to make large purchases for the investment to move the needle at Berkshire Hathaway. Altria (Phillip Morris) used to own 89% of Kraft. To buy 8.6% of Kraft Buffett would have had to buy 78% of the shares that traded. There was no way Warren Buffett could have purchases such a substantial stake in Kraft without moving the price significantly higher. It is quite possible that he had his eye on Kraft for some time. Altria’s spinoff of Kraft in April last year gave him the opportunity to build a big stake as existing Altria shareholders who recieved Kraft shares probably sold them off.

Why Kraft?
I must admit I don’t see this as a value pick. I think its fairly priced between $30-$35. I guess Buffett sees an improved future for Kraft. Kraft is now an independent company, the new CEO Irene Rosenfeld seems very competent. Kraft has also been undergoing some positive changes. The letter from Irene Roselfeld in the Annual Report points to an interesting change in how Kraft now views its products. Read Page 18 of the Annual Report. Finally Irene mentions the following “However, we will still have ample capacity for acquisitions. Our focus will be on building scale in key international geographies and on gaining access around the world to new categories, new capabilities and new technologies.” Kraft has a collection of great brands including Oreo, Gevalia, Jell-O, to Milka and Toblerone, but it currently has very little exposure to emerging markets. Kraft has an opportunity to increase sales and profits dramatically IF it expands its international business. Currently only 13.5% of Kraft sales are outside US/EU, compare this to 40.1% for Nestle and you can see where the opportunity lies. Irene has already taken the first step by buying Group Danone’s Snack business which get 25% of its revenue from China, Russia, Poland, Indonesia and Malaysia. Kraft can use the manufacturing/sales/marketing/distribution of the Danone business to unleash its US brands into the emerging markets.

Are these reasons enough to buy Kraft? Not for me, but as I said I probably missed what Buffett sees.

Disclosure: I do not own shares of Kraft but I have owned them in the past.

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So i am back with my favourite company. On August 23rd 2006 I calculated that the value of Berkshire Hathaway shares should be at least $120,000. Fast forward to August 23, 2007 and BRK-A closed at $118,800. Not too bad

Market Cap of Berkshire Hathaway = 212 Billion
Value of Individual Berkshire Parts = 246 Billion (Based on the Interim 3nd quarter report. Numbers used are 9 Months Net Profits *(4/3) for full year estimate values)

Recently Buffett has been making a few deals after nearly 1 year of inactivity. The 2 Billion of TXU bonds earning 11.2% and 11.8%. Buying 60% of Marmon for 4.5 Billion. Starting a Muni Bond Insurer. Purcasing ING’s Reinsurance business. All this point to Buffet finding ways to invest Berkshire’s cash hoard. The credit turmoil will create good buying opportunities for Berkshire. Finally at the next Annual meeting Buffet should have a couple of Investment managers lined up to take care of Investments going forward. All of this will add significant value to the shares in 2008.

The A shares of Berkshire Hathaway should sell for $163,000+ and the B Shares for $5400+.
** Investment gains or losses are recognized upon the sales of investments or as otherwise required under GAAP. The timing of realized gains or losses from sales can have a material effect on periodic earnings. However, such gains or losses usually have little, if any, impact on total shareholders’ equity because most equity and fixed maturity investments are carried at fair value, with the unrealized gain or loss included as a component of accumulated other comprehensive income. - From the Report

Disclosure: I own Shares of Berkshire Hathaway

Note: I originally wrote this article late last year after the 3Q Earnings were released but i never published it. It’s a little late since Berkshire will be releasing FY07 earnings soon and Annual Report is due in a month.

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Around 1:20 PM Eastern. Berkshire Hathaway class A shares crossed the $100,000 mark for the first time ever. This has been a resistance level for the stock for a few years. Berkshire Hathaway is a holdings company run by Warren Buffett. The company which started out in 1965 has never split its shares.

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Every investor wishes he had bought Berkshire Hathaway shares 25 years ago. If you had $10,000 invested with Warren Buffett in 1982 the shares would be worth $1,280,000 in 2006. Berkshire Hathaway shares are undervalued at the moment and will have consistent and above average growth for years to come, but the law of large numbers dictates that the company is too big. You cant get the same 25-30% annual returns from Berkshire Hathaway anymore. We missed out on Berkshire Hathaway but we could look for companies that may turn out to be “The Next Berkshire Hathaway”.

What to look for in the search for the next Berkshire or Buffet

• Company is run by a Brilliant money manager(s)
• It follows value oriented investing
• The investments are diversified across industries so a downturn wont affect the business.
• Insurance backed so the company can use float generated with positive underwriting to create wealth. Free money is always good.
• High levels of Management ownership, which orients management goals with those of the shareholders
• Focus on long term growth of Shareholder value and not on keeping the dumb anylasts on wall street happy every quarter.
  

It will be nearly impossible to find a perfect match but we can look for companies that match 2 or more criteria.

1. Sears Holdings led by Eddie Lampert (SHLD).
Eddie Lampert started ESL investments in 1988 with 28 million. ESL has averaged 28% a year for the last 18 years. Eddie Lampert is one of the best money managers in the world. Recently he took a bankrupt K-mart and turned it into a cash cow. He merged k-mart with sears to form sears holdings. The stock has been on a tear since Kmart came out of bankruptcy, it opened for trading at $16 in May 2003 and now trades at $160. Eddie searches for companies that are seriously undervalued, he also sticks to companies whose industries he understands. The board has given Lampert the freedom to invest the profits from sears holdings any way he sees fit. Just as Buffett did with Berkshire Hathaway in the 60s. If any person will take over from Buffett as the greatest money manager of the current generation it looks to be Eddie lampert, and the vehicle through which he will reach there is Sears Holdings.

• Brilliant money manager(s) - Yes
• Value oriented - Yes
• Diversified - Not yet but board has given Eddie Lampert the flexibility to do so.
• Insurance backed - No
• Management ownership - Yes
• Long term growth - Yes

2. Brookfield Asset Management (BAM).
A canadian asset management company which focuses on industries that need lots of capital such as real estate, natural resources, energy and financial service. Assets include 70 office properties, 120 power-generating plants, thousands of acres of timber and a property development operation under the Brookfield brand name. The stock has moved from $8 to $50 in 5 years thanks to the brilliant investments its management has made.

• Brilliant money manager(s) - Yes but not in same league as Buffett.
• Value oriented - Yes
• Diversified - Yes
• Insurance backed - No - Brookfield uses low cost debt which is the next best thing to insurance.
• Management ownership - Yes
• Long term growth - Yes

3. Leucadia National Corp led by Ian Cumming (LUK).
Leucadia is an investment company run by two brilliant money managers Ian Cumming and Joseph Steinberg. The company invests in anything that can make the shareholders money. Their preferred investments are generally turnaround plays. Leucadia will buy large stakes in a distressed company. They revive the company, improve performance and then sell it off at a nice profit. The company is currently diversified into telecom, manufacturing, healthcare, banking, real estate and wineries.

• Brilliant money manager(s) - Yes
• Value oriented - Yes but riskier than Berkshire as Ian cumming seems to go for higher risk companies
• Diversified - Somewhat. Cumming occasionally likes to make extremely big investment bets.
• Insurance backed - No
• Management ownership - Yes
• Long term growth - Yes

4. Markel (MKL)
Markel is an insurance holding company. The company is a mini Berkshire any way you look at it. Extremely steady and consistent growth. Like Berkshire the company has never declared a split and the shares have risen from their 1986 IPO price of $8.33 to nearly $400 in 2006. The company holds diversified investments in a large number of stocks. The top 10 current holdings are Berkshire Hathaway, Carmax, Diageo, Fairfax Financial Holdings, Anheuser-Busch, General Electric, White Moutains Insurance, Citigroup, Exel Ltd, Brookfield Asset Management. Its funny how they seem to like Berkshire and other companies that look like Berkshire.

• Brilliant money manager(s) - Yes but not in the same league as Buffett
• Value oriented - Yes
• Diversified - Yes.
• Insurance backed - Yes
• Management ownership - Yes
• Long term growth - Yes

5. White Mountains Insurance (WTM).
This company has Buffetts blessings. White Mountains is 16% owned by Berkshire Hathaway. The way the company operates it seems to be another mini Berkshire. The operating principles, view of the management and their operating principles are an exact match with Berkshire.

Operating Principles - White Mountains cares most about the following.

• Underwriting Comes First
• Maintain a Disciplined Balance Sheet
• Invest for Total Return
• Think Like Owners

Other Excerpts - “Intellectually we really don’t care much about leaving our capital lying fallow for years at a time. Better to leave it fallow and to wait for the occasional high-return opportunity. Frankly, sometimes shareholders would be better off if we just all went to play golf.”

“We also admire Benjamin Graham who said: “In the short run the market is a voting machine; in the long run it is a weighing machine.”

• Brilliant money manager(s) - Yes but not in the same league as Buffett
• Value oriented - Yes
• Diversified - Yes
• Insurance backed - Yes
• Management ownership - Yes
• Focus on long term growth - Yes

6. Interactive Corp led by Barry Diller - A Futuristic Berkshire Hathaway
Barry Diller (the CEO of IACI) says the comparison is “undeserved at present but not my hopes and dreams”. He also says that the web will help IACI fit its pieces together in a manner that Berkshire’s parts from Insurers to Manufacturing, just cant. IACI has sales that will reach 7 bilion this year and a ton of cash but the company trades at just 8.5 billion. The company is spread across a lot on industries including Retailing which includes Home Shopping network; Ticketing with Ticketmaster; Real Estate with Lending Tree, RealEstate.com and others, Online search includes Ask.com, Excite, etc..

I know IACI is a far stretch but the company is undervalued, has leading sites in their business segments a great CEO.

• Brilliant money manager(s) - Barry diller is an ok money manager but hes a brilliant CEO
• Value oriented - If theres such a thing as a value based investment on the internet
• Diversified - Yes
• Insurance backed - No
• Management ownership - Yes
• Focus on long term growth - Yes

Conflicts : I own shares of Berkshire hathaway and Interactive Corp.

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HAPPY BIRTHDAY Warren and CONGRATULATIONS to both of you.
Warren buffet married his longtime companion Astrid Menks on 30th August 2006 which was also his 76th birthday.The 15 minute wedding was hosted by his daughter Susie Buffet at her Omaha Nebraska home. Astride Menks has been Buffetts companion for the last 30 years.

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Berkshire Hathaway is my biggest stock holding Its “The Security I Like Best”. A lot of people ask me what Berkshire is worth in my opinion. I say the class B shares that are trading at $3100 are easily worth $4000+ (A shares would be $120,000+). How did I come up with the number? Berkshires cash and cash equivalents holdings are valued at cash value. Berkshires equity holdings are valued at market value. Then i value individual business units based on P/E multiples given to comparable companies by the stock market.

Market Cap of Berkshire Hathaway = 145 Billion
Value of Individual Berkshire Parts = 196 Billion (Based on the Interim 2nd quarter report. Numbers used are 6 Months Net Profits *2 for full year estimate values)

• Cash and Cash Equivalents - 42 Billion
• Equity Holdings - 52 Billion
• Subsidiary Insurance companies - 4.372B * 12PE = 52.464B
• Subsidiary Utilities and Energy - .782B * 14PE = 10.948B (Pacificorp excluded)*
• Subsidiary Manufacturing , Services and Retailing - 1.864B * 16PE = 29.824B (Iscar/Russel Atheletic excluded)*
• Subsidiary Finance and Financial Products = 0.744B * 12PE = 8.928B
• Investment and Derivatives gains = 0.8B (Excluded)**

The company has a 35% discount to its actual value (I think it should have a 10% Warren Buffet premium).
Based on this valuation class B shares of Berkshire should sell for $4200 and class A shares for $126,000.

* Berkshire has just acquired PacificCorp, Iscar Metalworking and Russel Atheletic but the earnings of these companies is not part of berkshire earnings yet.

** Investment gains or losses are recognized upon the sales of investments or as otherwise required under GAAP. The timing of realized gains or losses from sales can have a material effect on periodic earnings. However, such gains or losses usually have little, if any, impact on total shareholders’ equity because most equity and fixed maturity investments are carried at fair value, with the unrealized gain or loss included as a component of accumulated other comprehensive income. - From the Report

Conflicts: I own Shares of Berkshire Hathaway

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A great man once said “If you dont know money, know your money manager”.

If you think you, your money manager or your mutual fund can beat the market youre probably wrong. Sixty five percent of mutual funds wont beat the S&P 500 this year. Most of the ones that do beat it will fall short next year. Why invest in a mutual fund that cant beat the market? You can easily invest in an index fund.
So you still want to beat the market? If you cant beat the market find someone who can. The last thing you want is to be invested in a high flying fund just as its about to dive. You need a money manager who can beat it consistently and has proven it over long periods of time. There are other money managers that i consider superinvestors like George Soros and Bruce Sherman but it is not possible for the average investor to invest with them so they have been excluded. I must mention Masters’ Select Value a mutual fund that is a favourite of mine. Three of its Four money managers Bill Miller, Bill Nygren and Mason Hawkins are in my favourites list. Its a great way to get exposure to multiple superinvestors in 1 mutual fund.

Take a look at my favourite money managers. Most of these superinvestors have beaten the S&P over long periods of time (10 years or more).
Individual Stocks
Warren Buffet: Berkshire Hathaway (BRK.A, BRK.B)
Eddie Lampert: Sears Holdings
My personal preference here is Berkshire Hathaway. It is better than Sears holdings in virtually any comparison.

The 3 dollar Bills
Bill Gross: Pimco Bond Funds (Too many funds to name)
Bill Nygren: Oakmark Select
Bill Miller: Legg Mason
I find it hilarious that my 3 favourite mutual fund managers are all named Bill.

Additional US Funds
William Danoff: Fidelity Contrafund
Joel C. Tillinghast: Fidelity Low Priced Stock
Harry R. Hagey: Dodge and Cox
Ken Heebner: CGM Focus/CGM Realty
Mason Hawking: Longleaf Partners

International funds
Charles de Vaulx: First Eagle Global
Riad Younes: Julius Baer International

There are too many great mutual fund managers and i wanted to keep my list small. I feel that some names need to be mentioned even if they are did not make my favourites list. Here are a few more brilliant managers and management teams

Richie Freeman: LeggMason Partners Aggressive Growth
Christopher Davis: Davis New York Venture Fund
John Calamos: Calamos Growth Fund
Wally Wietz: Wietz Partners Value Fund
Jeffrey Bruce: Bruce Fund
Oakmark International
Dodge and Cox International
Matthews Pacific Tiger

Conflicts : I have investments in Berkshire Hathaway, Fidelity Contrafund and Fidelity Low Priced Stock

Confession: I am the great man who said “If you dont know money, know your money manager”.

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What if i told you there was a mutual fund with one of the best money managers in the world and had returned amazingly consistent growth every year for decades. What if i said that the fund had the flexibility of investing usually found only in hedge funds. What if i also told you that the fund had no load, administrative or management fees. The fund is diversified across sectors and also invests internationally. It holds stocks, complete companies, bonds and foreign exchange. The fund manager puts all of his own money in this very mutual fund thus completely aligning his interest with the mutual fund holders. As an added bonus the fund will never have distributions which force you to pay tax even if you still hold the shares.

The name of this amazing mutual fund is Berkshire Hathaway but its a stock and not a fund. Lets look at the company in detail regarding the claims I made.

Manager: Warren Buffett Nicknamed the “Oracle of Omaha” or the “Sage of Omaha”, Buffett has amassed an enormous fortune from astute investments, particularly through his company Berkshire Hathaway, in which he holds a greater than 38% stake. With an estimated current net worth of around US$42 billion, he is ranked by Forbes as the second-richest person in the world, behind only Microsoft chairman Bill Gates.

Returns: Since 1965 the company has averaged 21.5% returns in per share book value. This is one of the best returns for any company or mutualfund over any large period of time (10 yrs+). During the same period of time the S&P index has returned 10.8% and most mutual funds perform worse than the S&P.

Expenses: Mutual funds have a bunch of expenses and fees. Initial sales fees, Deferred and Redemption fees cut into your investments. The fees I mentioned are incurred only once. There are also Administrative, Management and 12b-1 fees that are charged anually whether the mutual fund makes you money or not. Since Berkshire Hathaway is a stock there are no fees. Warren buffet recieves no stock options and has an annual salary of $100,000.

Diversification: Berkshire Hathaway by defenition is a holding company owning subsidiaries and stocks engaged in a number of diversified activities.

Major stock holdings: American Express, Ameriprise, Anheuser Busch, Coca-Cola, M&T Bank, Moody’s, Petrochina, Proctor & Gamble, Wal-Mart, Washington Post, Wells Fargo, White Mountain Insurance

Minor stock holding: ConocoPhillips, General Electric, United Parcel Service, Nike, Home Depot, Costco

Major Subsidiaries: GEICO, General Re, National Indemnity, MidAmerican Energy, Iscar Metalworking

Minor Subsidiaries: Clayton Homes, Acme Brick, Ben Bridge Jewellers, Benjamin Moore, Borsheims Fine Jewellery, CORT Business Services, Fruit of the Loom, Garan, Helzberg Diamonds, HomeServices of America, Dairy Queen, McLane Furniture, Nebraska Furniture, Netjets, Pampered Chef, Sees’ Candies, Shaw Industries, Wesco Financial and more

Flexibility: Mutual Funds are restricted in what they can invest. Most funds are restricted by the valuation (Value vs Growth), Geographic (US vs International/Emerging Markets), type of Instrument (Stocks/Bonds/Currency). Berkshire Hathaway has no such restriction. It can invest in any type of Company anywhere in the world. It can also invest in any form of investment.

Taxes: Mutual funds are forced by law to distribute at least 90% of its’ realized capital gains and dividend income each year. You then have to pay taxes on the distribution. In the case of Berkshire since you just buy or sell the stock of a company, you only need to pay capital gains taxes when you sell the stock. In the meantime Berkshire can compound your money for you.

Conclusion: A company run by the best money manager of our time. It has the diversification of a mutual fund, flexibility of a hedge fund and the cost and tax advantages of a stock.

Conflicts - I own class B shares of Berkshire Hathaway.

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