A version of this essay appeared in Oddball Stocks Newsletter Issue 26. Stay tuned for the upcoming Issue 27 in about a month.
In a finance Twitter discussion about investment theses that revolve around sum-of-the-parts (SOTP) valuations, one astute person pointed out a big problem with these SOTP ideas: the “sum” rarely subtracts the net present value of the corporate overhead.
We have been seeing this problem with a lot of Oddballs recently. For example, Pardee Resources is focused on (mis)-allocating capital to new investments to justify their high SG&A expense, rather than selling timberland at once a millenium high cash flow multiples, cutting SG&A, and buying back stock. The result won't be pretty. Pardee's SG&A expense, meanwhile, is almost $7 million. Is this a perpetuity paid to headquarters staff? What is the appropriate discount rate to capitalize it? Whatever variables you plug into the calculation, the NPV is an unfortunately high fraction of Pardee's asset value.
Or take Avalon Holdings, which we have written about in the Newsletter before. The market capitalization of $7.8 million is only 21% of the book value of $37 million. Avalon is cheap relative to book value, but its assets don't produce much in the way of earnings. The balance sheet shows $73.1 million of assets (of which $46.8 million is property and equipment) financed with $13 million of debt, $21 million of current liabilities, and then the shareholders (and non-controlling interests') equity. These assets only produced $51,000 of operating income (EBIT) for the first six months of 2019!
The pattern at Avalon is that the company has been acquiring properties (like the Boardman Tennis Center last year for $1.3 million) and putting them in a vehicle whose equity trades at 21 cents on the dollar (of book value) and where the cash produced is eaten up by SG&A expense.
In general, these companies at discounts to sum-of-the-parts values (but not cheap based on dividends or cash flows) are suffering from an incentive alignment problem. Managements could stop buying assets, sell overpriced (i.e. low earnings relative to purported asset value) ones to third-parties, and return capital to shareholders. But managements need to own assets to justify being paid. And managers with bigger empires get paid more. (See our post, Small Companies (like Small Banks) As "Jobs Programs".)
With valuations at all-time highs and interest rates at all-time lows, there has never been a better time to sell assets and probably never a worse time to buy them. In Issue 26 of the Oddball Stocks Newsletter, one of our guest writers pointed out reason for the problems at diversified holding companies run by "capital allocators". We are at a cyclical extreme in what people are willing to pay for income generating assets, which explains the dearth of attractive “opcos” for capital allocators to buy. That is ultimately why the book value of Enterprise Diversified dropped to $10.7 million from $19.4 million a year ago.
We continue to see Oddballs – whether land-heavy companies, small banks, or other kinds – that trade for prices below liquidation value if managements sold and yet above the present value, at a reasonable interest rate, of the distributions that shareholders will likely receive over time.
Another problem we see is that investors have abdicated from supervision of their hired managements. Frankly, they are too cheap to engage in “activism” (as shareholder supervision is now known) because they had good results in the past without having to exert control over their investments.
This too shall pass. In the next bear market, micro-cap funds established post-crisis that take too much risk, older investors, and over-leveraged companies themselves will be forced sellers of Oddball shares at much lower prices. That is when it will pay to have studied and read about these companies.
Hanover Foods is a classic Oddball that has been written about on this blog a number of times over the years: the original posts (parts 1 and 2) back in 2012, and an update in 2013, among other mentions.
Over the past year and a half we've been writing about Hanover Foods Corporation (HNFSA/HNFSB) pretty frequently in the Oddball Stocks Newsletter. Will anything ever change there? Will value ever be realized? Both of its classes of stock have been in a slump and are back to where they were in 2011-2012. (Of course they have each been paying a small dividend of about $1.10 annually along the way.)
The annual report for the year ending June 2, 2019 just arrived in the mail. The market capitalization is now about $60 million, compared with net current assets of $127 million and common shareholders' equity of $229 million.
The common shareholders' equity is now $320 per share. This is up from the $250 per share when the idea was first written about on Oddball Stocks. Even ignoring goodwill and intangible assets the book value would be $309 per share - almost four times the price of the nonvoting A shares.
However one of our concerns has been that the Hanover business seems to be deteriorating. For this fiscal year, gross profit was $31.8 million, down from $40.8 million the prior year - a decrease of 22 percent. Operating profit dropped from $7 million to only $354,000.
Looking at the cash flow statement, the company had $17 million of depreciation and amortization over the two most recent fiscal years, but spent $25.3 million on purchases of property, plant, and equipment. That $8 million dollar difference was paid for essentially by liquidation of inventory over the most recent fiscal year.
Why was Hanover's profitability so poor? We know from the report that frozen and canned vegetable sales were up a little bit, but snack sales were down from $51.6 million to $44.6 million. Perhaps this segment was higher margin. It seems to consist of snacks like pretzels and cheese balls.
The annual report mentions that last June the company impaired the full amount of the goodwill associated with its snack foods reporting unit. Hanover also "ceased operating its direct store delivery business," resulting in an additional impairment of $2.1 million of intangible assets. These noncash charges drove up administrative expense and so are responsible for a fair bit of the year-over-year decline in profitability.
Hanover's business just seems to be in steady long-term decline. Between 2000 and 2004 sales were lower than today but gross margin was much higher, resulting in some decent profits. Hanover's market capitalization probably wouldn't be $60 million if it were still earning $10 million like it did in 2003 and 2004.
From 2000-2004, Hanover earned an average net income of almost $9 million: higher absolute profits on revenues that were only three-quarters of the current levels. One wonders how much of the declining profit margin is secular business decline and how much (if any) is coming from excessive insider compensation or expenses being run through the business.
On the plus side, since the market capitalization is only 26% of its shareholder equity, the low return on equity transforms into a shareholder earnings yield almost four times higher. (Of course there is the risk that the current, low profitability levels will deteriorate further or become losses...)
We have seen in the past that “one-day” good events can happen for shareholders of companies where the market price is too dislocated from asset values. And we have also seen low returns on equity turn into respectable IRRs for shareholders who buy in at very big discounts to book value. And one other thing worth mentioning – Hanover was probably the most hated Oddball at our Newsletter meetup this year. There was only one gentleman willing to raise his hand to say he had not given up on it!
We have written about Hanover in a number of recent Issues of the Newsletter (back Issues are here) and will continue to do so going forward.
Bubblicious? People still speak of bubbles a lot, bubble in the bond market, stock market, unicorns etc. But I still don't really see a bubble except in certain areas of technology. Otherwise, things seem to be in a normal range to me, except interest rates. They do seem a bit low, but having said that, I still see 4% as a decent 'normalized' long term rate for the U.S. (as I have said here before many times).
The Valuation Sanity Check shows the Dow trading at 20.6x current and 16.4x forward P/E, and the Berkshire portfolio (largest holdings) trading at 17.4x and 14.3x their current and forward earnings. Browsing down that page, there is nothing really alarming about anything, really. Some things look expensive, but nothing insane.
Also, here are some charts I plucked off the internet. The first bunch is from the JP Morgan Asset Management's Guide to the Markets. This is a nice report that they put out every quarter, and is fun to flip through.
These charts too show nothing really crazy.
I keep hearing people talk about how crazy it is that the market is up 20% this year, but given that a lot of that is recovering from losses last year, it doesn't sound crazy to me.
Also, people keep saying that the returns of the last 10 years suggests the market is overvalued. But again, given that the much of the returns is recovering from the financial crisis bear market, I think it's irrelevant. If the market had double digit returns over 10 years from a market high, then I would be more inclined to agree; something bad might be about to happen.
But this is clearly not the case here. In fact, from the October 2007 high, the market has gone up less than 6%/year (excluding dividends), and 3.4%/year since the 2000 peak. This is hardly the long term performance figures you see in a real bubble.
I won't look for them, but look at the similar figures for the 2000 peak, Nikkei 1989 peak etc. It is very different from today.
S&P 500 Index Forward P/E Ratio
The above forward P/E chart shows a normal range, nothing alarming. Of course, people will argue that the market has been consistently overvalued for the past 25 years so this is not indicative of anything. But interest rates are a lot lower now than in the past too, and this chart doesn't show any abnormally high P/E level due to lower rates. I suppose one can argue about the validity of EPS estimates a year out. That is certainly a valid point.
Forward P/E and Future Returns
This X-Y plot of forward P/E ratio versus future returns show potential returns solidly in the positive. I did something similar using Shiller's CAPE ratio and found similar results.
My analysis goes back to 1985, so is longer term than the JPM study (which goes back to 1994), but hasn't been updated (a couple of years shouldn't make a difference!).
MSCI World vs. S&P 500 Index
These charts show nothing extraordinary either. Yes, the U.S. market is doing really well versus the rest of the world. But who cares, right? Unless you are some sort of mean-reversion trader, it's not really relevant. I too tend to like investing in U.S. businesses, mostly because I live here and have access to all the filings, conference calls and things like that, and I do feel U.S. companies are more responsive to shareholders and the system works better (compared to Japan, for example, where I have very little faith that managements care about shareholders).
Median P/E Ratio And here's something I found. The S&P 500 is market-cap weighted, so the index P/E ratio tends to be influenced by the large cap stocks. When you have a bunch of large caps that are overvalued, it tends to push up the P/E ratio of the whole index.
To get a more 'typical' P/E ratio of the random stock, a median P/E can be more useful, as half the companies would be more expensive, and half would be cheaper than this level.
Again, nothing spectacular here. Looking at this (and the other charts), if someone is net short the market, you would have to examine their brains. Why would anyone be net short in a market like this? It doesn't really make sense to me.
Just flip through these charts again, and imagine you are the head of the trading desk at a hedge fund or bank somewhere. And say some guy is massively net short the market. You ask him why he is so short, and he tells you that it's because the market is way overvalued. What would you say? Would you feel comfortable going home and sleeping well? Of course, this trader may contribute to reducing the overall exposure of your desk, but don't think of it that way as you can always adjust your market exposure with futures.
If you think of it this way, it's sort of insane.
The other non-bubble thing is that you don't hear people talking about the market at all. Usually, in a real bubble, people really like to talk about the stock market in situations where that is not normal. A couple of years ago, everyone was talking about bitcoin. I don't hear much about that anymore these days.
Also, the news flow is so negative these days, whether it be Brexit, Trump tweet, U.S./China trade, Iran... Wherever you look, it's just bad, scary news. And yes, the market responds by going down, but it comes right back up. This is not to say that the market will always come back up. We will have a bear market at some point.
But if you are net short and all these 'favorable' developments to your position is not making you money, that's kind of a serious problem. What happens when any of these things resolves itself? What if we do get a blowoff that has happened in most other bubble tops (2007 top was not really a bubble in terms of valuations, so bear markets can happen from normal valuations too).
Value-Growth Gap The other thing is the huge gap between growth and value stocks. I am not that big a fan of this as the division seems arbitrary and kind of meaningless. But what is encouraging is that despite this slightly higher valuation of the overall market, the gap between value and growth seems to suggest that one can avoid a lot of pain by being more in the value area than growth.
Back in 2000 when the market was actually really overvalued, value investors did fine despite a 50% drop in the S&P 500 index as the drop was driven mostly by expensive companies going down in valuation. I think value stocks actually went up back then.
This may be true this time around too.
Market Timing Most of us value investors don't believe in market timing at all. It is so amusing to watch the market go down 200 pts (or more) on a tweet only to reverse itself within a day or two by another tweet. Why anyone would trade based on this stuff is beyond me. I am a believer that headlines almost never mark turning points in the market. If the market is making a new high and then plunges on some negative headline, you can bet that that high will not be a high of any significance. I have seen various attempts over the years to analyze peaks and troughs in the market and matching it with news headlines; there usually is no headline that marked the top or bottom of a market.
It's just silly to try to figure out when the next bear market will happen.
There is one thing, though, that I would watch out for. If the U.S. market goes into a situation like the Japanese stock market in 1989, then I would obviously react. I would definitely lighten up equity holdings (still on a case-by-case basis based on valuations, of course) and maybe even consider buying puts, going short or whatever (OK, maybe not as I watched many bears lose a lot of money in 1998-2000 period only for them to be proven right but already having lost too much money made no money on the decline).
In any case, it would be a valuation call; I would lighten up when I can't accept the valuation levels. And it would be by each individual holding, not some vague notion about the directions of the overall market or economy.
Japanification of Markets? The other worry is the Japanification of global markets. We were all baffled by the low interest rates in Japan for decades, and here we are with multiple countries and trillions of dollars in debt trading with negative interest rates.
Many commentators thought it won't happen here, and yet here we are with long term rates under 2%.
What about the stock market? Can the U.S. go into a bear market like Japan's that lasts 30 years? This sort of thing worries me too a little. We can't say it won't ever happen here as we were wrong about interest rates. Well, I've actually been in the camp of "lower for longer" so am not really all that surprised by how low our interest rates are.
But it would not be fun if the market went into a 30-year bear market.
Here's why I don't think it would happen, at least any time soon:
The Japanese market went up to 60-80x P/E at the time. That sort of valuation takes decades to grow out of, and it's that much harder when there is no growth! We are nowhere near that kind of valuation.
The Japanese government and companies spent most of the time since then hiding things rather than fixing them. When the U.S. had a credit crisis, banks were encouraged to raise capital and fix their problems, not hide them.
Regulations are meant to maintain the status quo, protect large companies (who are contributors to the LDP) etc.
In Japan, companies are discouraged from right-sizing. They run under a system the Canon CEO, Fujio Mitarai, calls corporate socialism. He says that since the Japanese government doesn't offer much of a social safety net, that burden falls to large corporations; they are strongly discouraged from firing employees. This is why there is a word for this category of employee: madogiwazoku (google it!). Here's an article about it: Boredom Room. It's no surprise that the stock market has been dead for so long with so many zombie employees at zombie companies. This is very different than in the U.S.
There are many other problems, but those are just some big ones off the top of my head... You may think of better reasons why Japan has been stuck for so long.
None of these are true in the U.S. That doesn't mean we can't go into a 30-year bear market, of course. But it just seems to me that it is not likely at the moment.
Hard Left Turn in Politics? Others worry about the progressive left; Leon Cooperman joked the other day that if Elizabeth Warren gets elected, the market won't open. I understand that fear, and as a big fan of JP Morgan, I totally get it.
I am actually pretty progressive myself (I used to be conservative but have been moving left over time), but I wouldn't worry about this at all.
First of all, we really have no idea what's going to happen. We don't even know who is going to be the democratic candidate; it's possible that someone else not even running now will come up out of nowhere (well, not sure if that's possible, actually, but we still have a long time to go).
We do know that Warren is as progressive as she presents herself, so this may not apply, but it's possible that she runs hard left to take Sanders' and other voters only to run back towards the middle if she wins the nomination.
We don't know what she can accomplish even if elected, right? This is a president, not a dictator. Did FDR or Kennedy destroy the country? I haven't looked at the market action around their elections, but I don't really think there is a big, visible dent or bend in the long term charts based on who was president.
So this is certainly a risk factor, but my guess is that things, as usual, will not turn out the way we expect even if Warren wins the election. It's a complex model and things aren't going to be so easy to predict.
A fellow Oddball sent in a new development for Vulcan International, the previously mentioned (in 2015 and 2018) Oddball that announced plans to liquidate last year but has not announced any progress with the liquidation or paid any distributions.
One of the company's assets is 14k acres of land and timber in the UP of Michigan. This has been placed on the market, with bids due on October 11th:
THE OFFERING American Forest Management, Inc. (AFM) has been retained to solicit sealed bids for 14,306± gross GIS acres of land and timber located in Houghton and Ontonagon Counties, in Michigan’s Upper Peninsula. This high-quality property will be offered for sale in its entirety as a lump sum, single-phase, sealed bid event. Offers will not be considered for individual tracts.
THE PROPERTY Vulcan is located about 25 miles south of Houghton in the area of Twin Lakes. This property is known to be a well-managed, high quality Sugar Maple forest. The Upper Great Lakes Region has numerous markets for many forest products, and Vulcan is well-positioned to take advantage of these markets. The property has an improved road system throughout, allowing for both summer and winter harvesting with little immediate investment. The productive acres of the property are better than average with less than 1% being non-forested.
DATA ROOM AFM has set up an electronic data room containing information for bidders to use as they evaluate the property. Access to the data room will be permitted only to prospective bidders who have executed a Non-Disclosure Agreement (NDA) as approved by AFM. The data room will be accessible to such prospective bidders starting on August 30, 2019.
OFFERING PROCESS Vulcan is being presented for sale in its entirety, as a single stage, lump sum sealed bid event, with no further option to subdivide. Prospective bidders are invited to participate in the process upon execution of the NDA. Final bids will be due October 11, 2019.
Lately the share price of Vulcan has been declining. It peaked at $140 last October but has dropped to $120, possibly reflecting concern about the lack of updates on the liquidation.We know that shareholders have been contacting the company and at least one sent a formal Section 220 request for information about what is going on.
(P.S. The timber sale will also be interesting because the value it puts on northern Michigan timber will be helpful in thinking about what Keweenaw Land Association's timber is worth.)
JPM's annual report is out, and maybe a good time for another post here. I know it's been a few months. Honestly, I have been coasting recently on what's been working and haven't been digging around too much in the stock market. Most of my time recently has been spent on programming, having taken on a few freelance gigs for fun (and beer money).
Website Anyway, I have updated my website. A lot of things there were broken, but everything broken there was just due to the Google and Yahoo Finance APIs being shut down completely. This is really annoying. There are a lot of books out there on AI, data science, quantitative finance and all that, and a lot of them depend on those APIs, so it's like those books are worthless now. Well, not really... you just have to find an alternative source of data. But who wants to deal with that hassle?
People are still talking about how overvalued the stock market is and how it has to go down, and how valuations do matter and that perma-bulls are saying valuations don't matter.
Well, I have been telling people to ignore those people for the past few years, and I, for one, would not say that valuations don't matter. Valuations do matter. The higher the valuation, the lower the future returns. Duh. This is not rocket science. This is no different than bonds. The higher the bond price, the lower the yield, the lower the future return.
Where I disagree with the bears is their conclusion: that if the market is overvalued, then the market must go down. (I am not arguing that markets won't ever go down; they will with 100% certainty. But I doubt anyone can tell us with any consistent accuracy when it will!)
I also quantified this and put the data on the website.
I didn't update it, but since the market has been up, the conclusion would be the same or better. Plus, the analysis uses decades of data, so a couple of years is not going to make a difference.
As for all the worries and concerns, Buffett's 2018 letter has a great section called "American Tailwind", and it basically says that the market has done well over the past 77 years and there were always things to worry about, but the market did pretty well. Maybe more on that in another post.
Anyway, the home page shows the trailing P/E ratio of the S&P 500 index at 21x, and forward P/E of 17x. This may seem high to some of us who started in the stock market business when interest rates were around 8%. They are now much lower than that. I've said in posts that with a "normalized" interest rate of 4% over the next decade, I would not be surprised if the market P/E averaged 25x P/E. So a 21x P/E is not at all alarming or shocking to me, and the 17x forward P/E actually looks pretty attractive, even assuming that forward estimates tend to be over-estimated.
Also, looking at the Valuation Sanity Check page, the Dow 30 stocks seem to be trading at 17.5x 2019 estimates and 15.4x 2020 estimates. The Berkshire stocks (just the stocks listed in the annual report) are trading at 15.4x and 13.4x 2019 and 2020 estimates.
Again, there are issues of the validity of 'estimates', but even still, these figures are nowhere near bubble levels.
My thoughts about the market hasn't changed at all in the past year. Yes, it was a little scary in the fourth quarter of last year, but I was not that particularly worried as none of my work (as shown in previous blog posts) has shown any rubber band stretched to it's limit that must snap back.
OK, anyway, maybe more on that another time. Going on to my next pet peeve...
Data Google and Yahoo have no obligation to continue their finance data APIs, of course. But what is really annoying is how expensive simple financial data is. It has always been so, and Google/Yahoo made it affordable (or, well, free) for the little guys without big corporate budgets. But that is gone now.
As the world continues to move towards open source and open data (look at this great source of free data related to NYC: NYC Open Data), the financial industry continues to be closed and expensive.
There was an article in the FT today about people (even rich corporate users) complaining about stock exchanges gouging them on price for access to basic data.
As I see it, stock exchanges are basically public utilities. I don't think they should be profit-making entities so long as they are given a legal monopoly (or oligopoly or whatever).
It's just makes no sense that we stock market traders/investors must go through the exchanges to trade and the exchanges then accumulate and use that data and sell them for profit. It just makes no sense at all. This stuff should be public information and easily available to the public in various forms. It doesn't cost that much money to provide an API where people can access this information. We can see they are already making tons of money on exchange fees etc.
So this is just nuts.
OK, so it's not a huge issue for me as stock prices / data is not a big part of what I do. As you know, I am more about listening to conference calls and reading 10-K's and stuff. The only time I use financial data was when I was putting stuff up on the website for fun; I don't need that stuff to invest (and that's why I haven't paid for any data service, and don't really plan to).
The idea of open-source is that if you make the information free and widely accessible, more people can play with it and more ideas can come out of it.
OK, enough of that...
JPM 2018 Letter No offense to Mr. Buffett, but I sort of look forward to Dimon's letter more than Buffett's these days. Buffett still writes great letters and I read them as soon as they come out. But I feel like I am very familiar with what he has to say and there are usually no surprises, and I am not sure I really learn anything from reading them lately.
But Dimon's letters are much more granular and deal with a lot of specific, current issues etc.
Anyway, I don't plan on going into detail here as you can just go read it yourself (and I know many of you won't, but I don't care... it's your loss if you don't!).
Here are my usual favorite charts.
Dimon Tenure Performance These tables are really great; they show how Dimon has done as a CEO.
For reference, BRK BPS grew +9.5%/year from 1999-2018 and +10.0%/year from 2004-2018. So you can see that JPM has done better than BRK in both time periods, which is kind of shocking when you think about the fact that one period includes the popping of the internet bubble in 1999/2000, and both time periods include the financial crisis. (BRK time periods are based on year-ends, so don't match up exactly, but whatever...)
Below is the same look but based on the stock price instead of TBPS. BRK's stock price appreciated around +9.3%/year in both time periods (1999-2018, 2004-2018). This is kind of insane.
Social / Political Issues I will not repeat them here, but Dimon goes on in great detail about how we can make things better here in the U.S. It's too bad that our system does not allow for people like Dimon to become president. He would make an incredible one.
Anyway, he does caution us away from the creeping socialism and rising progressives from the far left. I am actually very sympathetic to this recent movement even though I am a hard-core capitalist. But I can see how it can be dangerous for us to veer too hard to the left and destroy things that have worked for us.
But the fact is that what has worked for "us" hasn't really been working for a very large number of people.
Conclusion It's been a while, but I haven't really changed my mind on anything at all. Nothing new to report, really. The market looks fine. No bubble at all as far as I'm concerned. Maybe not cheap, but not really that expensive either.
The way stock exchanges use data as profit centers is deeply disturbing and is not consistent with what I think of as their mandate as virtual public utilities. The whole system of exchanges charging money for data, and a whole industry of data vendors runs contrary to the worldwide trend everywhere else of open-source and open-data.
OK, way back in the old days when you needed expensive mainframes to manage this stuff, it may have been understandable. But with technology where it is today, this whole data industry setup and cost makes no sense at all. The industry must be laughing their way to the bank as costs keep going down and the prices they charge keep going up.
JPM continues to do well and it looks like in may ways they are disrupting themselves, which is really great. It assures (or increases the odds) of their continued success.
They have come a long way since I opened my first bank account at Chase many years ago.
I probably told this story here before, but I'll tell it again. When I had my first job in the city, I needed to open a bank account somewhere so my employer can deposit my paycheck.
I figured all big banks are the same, so I went to the World Trade Center (near where I worked and lived) and walked into Citibank. There was a reception desk at the front and I said I wanted to open a bank account.
A big-haired girl, loudly chewing gum and filing her nails barked at me, "I'm on break. Come back later...". She was sitting at the reception desk/booth. I was shocked at how rude she was, so I just walked across the hall to Chase and said the same thing, and someone immediately came and helped me out. Chase was not that much better; it was pure chance that the Citi employee was on break and Chase's wasn't.
This is the only reason why I started at Chase. Unbelievable. But that's how big banks were back in the 90's. Just terrible. Like the post office.
Anyway, JPM is no longer no-brainer cheap like it was when this blog first started (2011), but it still seems pretty cheap.
Every now and then, BRK comes up in conversations with people (and often with people not in the business) and the topic becomes, what to do with BRK post-Buffett. I tell them I own BRK and plan to own it for a long time, and sometimes I wonder why myself.
Too Big First of all, it's really big now so it's going to be hard to grow the way they used to. With a market cap of more than $500billion, it's going to be hard to keep growing at a high pace. This used to be sort of the cap in big company capitalizations; a lot of the bit techs went to $500 billion in 1999/2000 before they all came crashing down. The barrier today seems to be $1 trillion; Maybe these $1 trillion companies hit that wall and come crashing down. Who knows.
In any case, BRK is just too big to get too much alpha going forward.
Buffett Buffett is not so young anymore, so the historical performance is getting increasingly less relevant; Buffett created the performance of the last half a century, but he is clearly not going to lead the charge for the 50 years. This doesn't mean BRK can't outperform.
Buffett hired some great managers to help manage the equity portfolio, but their historical performance is sort of irrelevant too. Those guys posted great returns with a much, much smaller capital base. They will eventually inherit a $200 billion+ equity portfolio. If they want to stay focused, they will need to invest in companies they can buy $10-20 billion worth of. And there aren't a lot of those. Their universe will be no bigger than the one Buffett is fishing in now, so it's hard to imagine they will improve on what Buffett can do with this size.
Returns Not So Great Lately And people say that BRK hasn't even been performing all that well lately, underperforming in the past five years. The rolling five-year BPS growth vs. the S&P 500 index total return has been negative for the last five years in a row (through 2017):
People often point to this to show that the era of BRK outperformance is over.
But this sort of misses the fact that back in 2008, the S&P 500 was down -37% while BRK's BPS declined only -9.6%. So in a sense, the S&P 500 index had a lot of catching up to do compared to BRK. Looking only at the above table of the last five years misses a lot of crucial information.
Having said that, it's true that the supergrowth of BRK ended back in 1998, but has been a steady grower since then.
Check out the below log chart since 1980. You can see two clearly different eras in terms of performance. 1980-1998 was just amazing, but 1998-2018 has been much more modest (data just happened to be available since 1980 as I was playing with daily data; no cherry-picking start/end points. Good enough for this analysis).
BRK, Log Scale Since 1980
BRK's BPS grew +28%/year from 1980 through 1998 vs. +18%/year for the S&P 500 index for an outperformance of 11%/year. BRK's stock price rose +33%/year in that period, beating the index by 15%/year.
Since then, things have flattened out a little, but the returns aren't that bad at all.
BRK vs. S&P 500 I haven't updated this table in a while, but let's take a look at BRK's performance against the S&P 500 index (total return) in various time periods.
BRK vs. S&P 500: Various Time Periods
Of course, we know how great the performance has been since 1965. But check out the past five years. On a BPS basis, BRK underperformed the S&P 500 total return, but outperformed based in BRK's stock price.
If you look at all the time periods, though, BRK has outperformed both on a price and BPS basis in most time periods.
This year, it just so happens that the 2007-2017 is the same as the 10-year comparison so be careful to not double count...
But to me, more interesting than looking at the past 5 and 10 year returns (which are no doubt important), is to look at 'through-cycle' performance.
The lower part of the above table shows returns from various market peaks (year-end basis). You will see that on a BPS basis, BRK has outperformed the S&P 500 index since the 1989, 1999 and 2007 market peaks, and also on a price basis in most of those time periods.
The 1998-2018 BRK log price shows a more modest pace of growth than the 1980-1998 period, but you will see that BRK has still grown 10%/year since then, bettering the S&P 500 index (including dividends) by 3%/year on a BPS basis and 2%/year on a price basis. Not like it used to be, but not bad! (How many funds can you name that has done as well?)
So all this talk of Buffett not performing well is not so relevant to me.
It looks funny to have both 1998 and 1999 in there, but 1999 is there as a market peak, and 1998 for sort of a momentary peak in relative performance of BRK, and sort of the end of the high-growth era for BRK.
Why BRK? Despite the size, and the potential risk of a post-Buffett BRK, why do I still like BRK? First of all, the recent performance, I don't think, is as bad as people make it out to be. They are still outperforming in most time periods, especially from various market peaks.
There is something about BRK that makes me more comfortable than owning the S&P 500 index, even with the post-Buffett risk. The first thing is that BRK will probably not do anything irrational or stupid. This is not an assurance we get when investing in the S&P 500 index. The index committee will add bubble-ish stocks at bubble-ish prices. BRK will not be 'forced' to buy stocks just because they are 'big'. They will only buy stuff when it is high quality and is priced rationally. These are two things that the S&P 500 index committee do not seem to care about too much.
Sure, this inflexibility with regard to price and quality will be a drag on performance during certain time periods (like now, and back in the late 1990s), but I would feel more comfortable when my money manager is not chasing big stocks.
Also, check out the below chart. It's just the S&P 500 index since 1980 along with the BRK/S&P 500 index ratio. I just wanted to see, visually, how BRK has performed (price-wise) versus the index over time.
And what I see is kind of interesting.
S&P 500 Index and BRK/SP500 Ratio Since 1980
BRK seems to not do too well in late periods of raging bull markets (like the late 1990s) but seems to pick up a lot of relative performance during rocky times. This is kind of important for conservative investors. Whatever you think of the stock market now, there are pockets of bubbliness, and if that pops, it wouldn't surprise me if BRK has another big step up in relative performance like in the two circled periods above.
This sort of makes sense, right? As BRK doesn't have a whole lot of exposure to FANG/FAANG stocks. And if the market does decline a lot, that will provide a lot of opportunities for BRK to deploy cash so you are kind of sitting on cash optionality by owning BRK.
Yes, BRK declined 50% during the crisis, no better than the S&P 500 index, but if you look at the above table and charts, you will see that BRK does ratchet up relative performance during tough times. So just comparing peak-to-trough drawdowns sort of misses some important information.
By the way, here are some large declines in BRK stock over their history (from the 2017 Letter to Shareholders):
Stunning Discovery OK, maybe not. But I just noticed something. Look at the above chart again; BRK price / S&P 500 index ratio. If you look at this chart, you will notice that the uptrend is pretty consistent and linear. OK, I am not going to go back and put a regression line on it (too lazy), but you can sort of imagine a straight line going through it from the mid-90's even through today.
Here is the chart again with the line I sort of see (this is not a regression line, but one I just drew by hand). The lower chart is the BRK/S&P index ratio:
And, importantly, there is no kink, bend or flattening after 1998!.
What does that mean?! It means the rate of BRK's outperformance against the index has been pretty consistent and hasn't tapered off at all!
The ratio will measure the 'rate' of outperformance, not the absolute difference.
Here's what I mean. The above chart is based on prices, but I will look at BPS growth instead as the prices data is a little too spikey (and too sensitive to start/end points). As we saw above, in the period 1980-1998, BRK's BPS grew at a rate of 28.2%/year versus 17.7%/year for the S&P 500 index (total return), for an outperformance of 10.5%/year. Since then, BRK's BPS grew 9.5%/year vs. 6.2%/year for the index for an outperformance of 3.3%/year. Looks like big degradation in relative performance.
But the linearity of the above ratio chart made me look at this another way. The 1980-1998 28.2%/year is 1.6x the index return, and the 1998-2017 BPS growth of 9.5%/year is 1.5x the index return!
So, from now on, I am inclined to answer the question, "How do you think BRK will perform vs. the S&P 500 index in the future?" with, "I think it will do 1.5x better!".
Nonsense? Maybe. But it looks interesting to me. This is the danger with playing with charts.
Optionality at Low Cost Moving on. This is not a new idea, but we can see all the cash at BRK as optionality (even though I have long said that the cash is matched pretty closely to float so wonder how much of the cash is actually immediately deployable. Some of the float might be 'fast', meaning maybe they actually can deploy a lot of that cash and run down the float if necessary).
A lot of funds held a lot of cash since the crisis and have severely underperformed the index. The worst fund managers have actually been net short since the crisis and have catastrophically posted negative returns for years on end. Sure, these guys had plenty of opportunity because they were short; if the market went down, they could profit on the decline and then use the profits to go long and make even more money! But, those guys were neither prudent nor rational, and it is unlikely they will ever be able to make up the damage as it is just too big to overcome.
And yet, here, we have BRK with all that cash and it seems like they haven't sacrificed all that much in terms of performance. That is really amazing when you think about it.
Leverage By the way, BRK has $97 billion of cash/cash equivalents on the balance sheet just looking at the Insurance and Other segment. This makes people say that Buffett is bearish the stock market. Well, it's true that Buffett has been having trouble finding stuff to buy, but that doesn't necessarily make him 'bearish'. There is a difference between not finding things to buy, and being bearish (and expecting a market decline).
One thing that occurred to me when thinking about this huge amount of cash and short term investments on the b/s is how small the investment in fixed maturity securities is: $18 billion.
So first of all, the amount of cash/cash equivalent sort of seems to me like more of a bearishness or unwillingness to buy bonds than stocks. There is only $18 billion worth of bonds in the insurance segment versus, what, $200 billion in stocks? That's not bearish stocks to me, that's more like, bearish bonds!
Not to mention BRK has been net purchasers of stocks; not the act of a bear.
Here's the other thing. When we look at insurance companies, we often look at investment leverage. For me, since I like risk, I look at the percent of shareholders equity invested in stocks. Markel looks at and talks about that, as it's a big source of their expected BPS growth.
So I think about BRK in the same way. Forget about cash vs. float and all that stuff for now.
Let's just look at how levered BRK equity is to 'equity'.
First of all, the portfolio (including KHC) is $219 billion at the end of 3Q 2018. That's against $379 billion in total shareholders equity (including minority interest). So the ratio of shareholders equity invested in stocks is 58%. That's a lot higher than any other insurance company, and I think higher than MKL has been recently (maybe they are much higher now; too lazy to check now).
Of course, this is not like the old BRK, but not at all overly conservative either.
Now, keep in mind that BRK has a lot of unlisted businesses. For example, the various businesses in the railroad, utilities and energy used to be listed companies. If these were still listed, they would be included in equities. As far as growth potential is concerned, other than not having to mark to market, these businesses are basically no different than the equity portfolio (ignore the advantages of wholly owned businesses etc.).
So from the 'leverage' point of view, we can add this to the equity portfolio. The book value of this segment is $96 billion. With a similar argument for the Finance and Financial Products segment, we can add another $24 billion.
Sum that up and you get 'equity investments' of $339 billion. That's against total shareholders equity of $379 billion. So that's already like 90% of BRK's shareholders equity invested in equity of businesses. That's really not all that bearish!
This, by the way, doesn't even include the other unlisted businesses, the Manufacturing, Service and Retailing Operations (MSR), which is the 'other' in the Insurance and Other segment. BRK doesn't disclose the balance sheet in detail for this segment, but in 2016, BRK equity in the MSR segment was $92 billion or so. Add this to the above $339 billion and you get $431 billion worth of equity investments at BRK against it's shareholders equity of $379 billion.
This is why you get equity-like returns on BRK despite BRK having so much cash/cash equivalents on the balance sheet. This is hardly the balance sheet of a bearish CEO.
Conclusion I haven't even touched valuation here, but from all of the above, I like BRK a little more now than I have liked it in recent years.
I don't want to time the market and call a peak or anything. I have made it clear that even though we may enter a bear market or have a severe correction at any time, there doesn't seem to me to be a strong case to be made for an extended bear market in the U.S. at the moment (famous last words... I know!)
But the more frothy things seem (well, less so now with the October/November corrections), the more interesting BRK becomes for the above reasons.
AND, it is possible that you won't give up much in terms of performance to buy this 'optionality', with, of course, the greatest investor of all time ready to pounce if we have any big disruption in the market. And we can't forget that BRK has a lot more levers to pull than most conventional funds or even hedge funds; they can buy private businesses too, or do add-on deals to augment the many businesses they already own.
Plus, all that cash on the balance sheet doesn't mean it's as much a drag on BRK's performance as people make it out to be.
As for a post-Buffett world, I think what we need is intense rationality and discipline not to do stupid things. We know BRK is not going to jump into Bitcoin, or buy into bubble stocks (I fear we may find AMZN in the 13-F at an entry price of $3000 some day; that may be a sell signal!), panic and sell out stocks during a crisis or anything like that. And they will not be subject to quarter-to-quarter performance pressure in fear of redemptions. Many of these (and other) advantages are enough to keep me comfortable with BRK for a long time.
Also, even though BRK is not growing the way it used to, and it doesn't look like they are outperforming as much against the index, it looks like a lot of this is due to lower returns in the market in general as the rate of outperformance has been remarkably consistent even after 1998.
By owning BRK, you sort of get paid at least market performance while you wait for the optionality to be exercised!
So Buffett finally buys some JPM. He owned a bunch in his PA years ago and said it would be a conflict to own both JPM and WFC within BRK, or some such thing. I guess recent events (WFC scandals) have made him change his mind (as he may be starting to dump WFC). I've been a big fan of JPM for years, so naturally, I like this move. I wonder if Jamie Dimon would ever make it onto BRK's board; he would be a great fit there and would give the board some real, hands-on expertise in the financial industry (there is plenty of talent there, but noone with Dimon's experience/background).
This is the 13-F that was just filed (includes only positions over $1 billion):
Market Cap to GDP Someone asked in a comment the other day what I thought about the market cap to GDP ratio, Buffett's once favorite stock market valuation indicator. This, like many other valuations measures, is really dependent on interest rates. If you believe (like I do) that interest rates drive the valuation of assets, then prices are high when rates are low and vice versa. So, of course, if interest rates are low, the market cap to GDP ratio will be high. But that tells us nothing about the valuation of asset prices as it has to be compared to interest rates. Plus, it doesn't really tell you anything about interest rates either. (A lot of bears like to point to 'overvalued' indicators, like this market cap to GDP, P/E, CAPE, EVITDA/EV, Dow-to-Gold ratio etc. But often, it's all the same thing, so it's like double counting. They all point to one thing: asset levels are high because interest rates are low. But, people still think of these above factors as separate, discrete pieces of evidence to show the market is overvalued.)
Not to mention, many U.S. companies are growing globally, so their sales and earnings from non-U.S. business will be capitalized in the U.S. stock market while the GDP will not include those new territories. If a U.S. company merges with a European company, the stock market valuation may well increase (while GDP does not). Also, when Yahoo owned Alibaba as Alibaba took off, the U.S. market cap of Yahoo (and therefore the U.S. stock market) increased (with no increase in GDP).
So in that sense, I don't think it's a relevant measure of anything these days. I still like to adjust interest rates to what we might think is a normalized rate, and then price assets off of that.
BRK Corporate Governance Again, from the comment section, someone mentioned an analyst or author that is comparing BRK to fraudulent companies; BRK's corporate governance standard is comparable to historical frauds (ENR etc.).
Well, I am preaching to the choir here, and maybe I am just an ignorant, blind, cool-aid drinking BRK groupie, but every time I read these comments, I think it's ridiculous. It just takes a little bit of common sense to figure out the difference between BRK and the big corporate frauds in the past.
First of all, just for fun, I took a quick look at the corporate governance score of BRK on the Yahoo Finance page, and was surprised at the high score: 9 out of 10!
Berkshire Hathaway Inc.’s ISS Governance QualityScore as of November 1, 2018 is 9. The pillar scores are Audit: 1; Board: 10; Shareholder Rights: 8; Compensation: 6. Corporate governance scores courtesy of Institutional Shareholder Services (ISS). Scores indicate decile rank relative to index or region. A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.
Not bad! But then, reading further, I realized that 10 means high risk, lol... Oops. So it is, in fact, the way I thought it would be. Just to be sure, I checked this at the ISS website.
Governance QualityScore uses a numeric, decile-based score that indicates a company’s governance risk relative to their index or region. A score in the 1st decile (QS:1) indicates relatively higher quality governance practices and relatively lower governance risk, and, conversely, a score in the 10th decile (QS:10) indicates relatively higher governance risk. Companies receive an overall QualityScore and a score for each of four categories: Board Structure, Compensation/ Remuneration, Shareholder Rights, and Audit & Risk Oversight.
WFC, by the way, with all it's scandals, has a QualityScore of 1.
Out of curiosity, I looked at MSFT and check this out:
Microsoft Corporation’s ISS Governance QualityScore as of November 1, 2018 is 1.The pillar scores are Audit: 1; Board: 1; Shareholder Rights: 1; Compensation: 3.
MSFT OK, and check this out from the proxy:
The vast majority of our global employees participate in an annual anonymous poll. Here is a selection of results:
That sounds crazy too, for a large corporation. I don't know how 'real' this is, as we all know how people may be 'nudged' to fill out surveys in ways favorable to management. Well, they say it's anonymous, so OK, maybe it's legit.
I have become in recent years a big fan of MSFT, both as a user and an investor.
My MSFT Experience
I have been tied to MSFT for most of my career as company PC networks were usually run on Microsoft and desktops were usually Windows NT or whatever. Of course, we also had Unix machines running the serious stuff, but most office work, spreadsheet work and whatnot were done on Windows machines.
After going out on my own, I stuck to Windows, but I got increasingly frustrated at how often Windows would crash/freeze. Some days, I thought I spent more time waiting for things than actually doing any work. And then they killed XP (which I had on some of my old machines).
A programmer friend suggested I look at Linux, so I did. I installed Linux on my old laptop and eventually one of my old PC's, and I loved it. It was rock-solid and stable, like the Sun workstations (Unix) I used to work with that you never had to reboot or restart. I was seriously contemplating switching everything over to Linux and ditching MSFT altogether.
One thing holding me back was that a lot apps written for Windows is not available in Linux (well, you can still run Windows apps with Wine, but I was a little skeptical/worried that there would be issues if there was another layer). Otherwise, I loved everything about Linux. I use GIMP now all the time for photo processing (like the Buffett photo in my last post), Libre Office is great and is getting better etc. Plus my Linux machines never just randomly go into these long updates.
Well, one of my favorite things is how easy it is to run cron jobs in Linux versus Windows; I really hate the Windows task manager. A lot of other things are just so much easier to do off the command line in bash (although Powershell is getting pretty powerful, but it's so clumsy/clunky, I don't feel like learning how to use it properly).
Back to Windows
But OK, I never abandoned Windows. But what sucked me back in and made me abandon the idea of switching over completely to Linux was Windows 10. I was skeptical, but upgraded all my Windows machines to Windows 10 (forgot when), and I have been very happy. Yes, if you are not careful and don't set your 'active' time, it can go into long update cycles rendering your computer unusable until the updates are done. This is forced so you can't stop it. But you can tell Windows what hours of the day you will not be using the machine, so the forced updates will happen in those inactive hours.
OK, small problem.
But since switching to Windows 10, I have had very, very few problems I used to have. Random crashing, random freezing etc. I have not had that occur much at all and it's been a pleasant surprise.
Also, Windows 10 comes with Ubuntu bash so if you like Linux command line stuff, you can do it all in a bash terminal right on the Windows 10 machine and in those drives/folders that Windows runs on (goodbye cygwin?!).
The other major thing that drew me back to Windows is OneDrive. I used to do work on my home desktop and my laptop, and I used to have to email files back and forth to work on them. You can use Google Drive, Dropbox, Box etc. to sync files on your various machines, but I never got around to doing that with the above, and I didn't like how Google Drive seemed to keep altering my files (especially programs) when I uploaded them.
But OneDrive was so easy and is basically already set up from the get-go in Windows 10. Now my most active folders are on OneDrive, I never have to worry about syncing anything; it's all done automatically.
I think this is one of the big things that got me tied to Windows now. Plus, I am playing with Azure now and it is very easy to create Linux instances (basically virtual machines in the cloud) so you can write bots and set them up to run as cron jobs and your tasks will be done whether your PC/laptop is on or not. Plus they have databases and many other cloud services (I use Amazon too, but mostly for fun/experimenting). So when you think about how all of this is integrated and everything works great with each other, you can see how excited I am about MSFT. A programmer relative told me a few years ago that MSFT sucked for most of their existence, but that with C#, Azure and other cool things, they are becoming a really incredible company. (I am also experimenting with C# but haven't created anything for actual use). Of course, at the time, I didn't really look into it or understand.
Anyway, this is sort of relevant, right? As IBM just bought Red Hat, which is a Linux business. Anyway, I still love Linux and have a Linux box sitting next to my main Windows 10 machine. Linux will continue to grow, and behind the scenes, Linux runs everything, and will run even more going forward.
And check this out. I just recently noticed that Stanley Druckenmiller is big into MSFT:
So he is probably seeing and hearing the same things I am talking about. Well, OK, I have no idea why Druckenmiller is long MSFT. But I would assume it has something to do with what I'm talking about.
Oh yeah, and I really enjoyed Nadella's book: Hit Refresh.
With the FANG/FAANG stocks so popular, who knows, maybe MSFT is the tortoise that surprises everyone!
Back to BRK
OK, so there is probably not much I need to say on how silly it is to criticize BRK's corporate governance. Check this out from the BRK 2018 proxy:
This list doesn't show a group of people who really need the money. I think the average compensation for a big company director is something close to $300,000. If you wonder why so many board members seem to be yes-men to the CEO, this may be one reason why; it's good money! Don't rock the boat, keep quiet and keep cashing your checks!
It's clear from the above table that BRK directors are not there for the money. And sure, they are friends with Buffett so are they really independent? I would rather have directors that understand Buffett and BRK well, and have enough of a spine to express themselves if they see something they don't like.
There is a lot more to say on this but one of the biggest arguments in support of BRK's structure is that Buffett himself is the largest shareholder of BRK, so if this was a fraud, who is he defrauding? Himself? That's laughable. He takes a $100,000 salary but the bulk of his wealth is created by BRK's stock.
This is the opposite of most situations, where managements own token amounts of stock (and dump their stocks whenever they exercise their options) and pay themselves massive amounts of money. When you own very little stock but pay yourself huge amounts, I think that incentivises fraud more. Don't you think?
When a CEO has 99% of their wealth tied up in a stock, that is stronger than any corporate governance factor I can think of.
But corporate governance specialists, critics and academics don't seem to understand that. They would rather check the boxes on what they inflexibly think of as good corporate governance practice and that's it. I guess part of it is laziness, and part of it is just practicality.
Institutions that own a large number of companies can't possibly evaluate that many CEOs, BODs, etc. so they need some simple measure to save time. Like P/E ratios, maybe. Those that don't know how to evaluate businesses may have to depend on P/E ratios to evaluate cheapness, but if you know how to evaluate businesses, P/E ratios often don't really matter (as they don't tell the whole story, like, in the case of BRK!).
Abdication/Transparency I mentioned this in the comments section of another post, but the other issue is that Buffett is so hands off the businesses to the point of abdication. But this is misleading. We all know Buffett watches numbers like a hawk. He said he gets faxed sales figures every day from various businesses and he looks at them carefully every day.
What he means when he says he is hands off is that he doesn't micromanage. He doesn't insist on seeing every ad before airing. He doesn't want to interview and approve every new hire. He is not going to approve every paint job of a store, or pricing/marketing strategy of each business. He is not going to approve each detail of every budget for every line of business.
But this doesn't mean that he isn't watching every penny that goes in and out of the businesses. We all know that all of the free cash of a business is sent to Omaha, so if something is wrong, he will know right away.
For the businesses where things may get funky, like the insurance businesses, those are highly regulated, and Buffett is very closely monitoring those businesses and is very involved as he says, with big blocks of business (talks to Jain several times a day etc...).
As for transparency, I don't know. I never thought BRK lacked transparency. It could disclose more, of course, but I never thought of BRK as a complete black box or anything like that. Major business lines are presented clearly and in detail. Some of the non-insurance businesses might be opaque, but each of them are just too small to disclose separately.
Some fuss is made about the Sokol incident, but those things will happen every now and then to any company. Goldman Sachs has a lot of legal and compliance infrastructure, is highly regulated and constantly audited, and yet we now have the 1MDB scandal. So I don't know that the Sokol incident proves anything about BRK either way. You have to look at the big picture and see the kinds of problems they've had over the years, and the record is pretty good. Will another scandal happen? Yes. These things will happen. It's how management deals with it that will determine the fate of BRK, and I have faith that they will deal with any issues in the future promptly.
As Munger says, it's all about incentives, and I think BRK people are properly incentivized.
Remember what Buffett said after the crisis. He said that there was a regulator who had one job, and that was to regulate FNM and FRE, I think. And they failed. So just because you have someone watching and regulating, if the incentives are not correct, you are going to have problems.
So, I was a little irked when the market was down 600 points the other day when I was on my way out of the house. I know I don't really care, but still, at the back of my mind, I think, is this it? Is this the end of capitalism? Are we going to go down 90% like we did in 1929-1932? OK, I wasn't that worried, actually.
But it made me curious. Why are we so scared of big market moves like this? 600 points is a little more than 2%. Back in the late 1980s and early 1990s, a 2% move would have been a 50 point move. 600 points is psychologically shocking because Black Monday was a 500 point drop. So it feels like Black Monday again (that was before my time!).
I tend to buy into narratives I don't really care about. The HFT/quants are making the markets more volatile. ETFs, especially leveraged ETFs are making the markets more volatile. More regulation in the markets and the resulting decrease in liquidity (thinner bid/ask from market-makers/specialists) are making the markets more volatile etc...
I go, hmm... OK. Probably true. But whatever. Doesn't matter to me.
But sometimes, I suddenly think, wait a minute. Is all of this true?!
Let's take a look!
First of all, let's just take a look at the market's volatility on a rolling 100-day basis. This is what derivatives traders would call the 100-day historical volatility. I looked at this going back to 1950. All of the following charts include data up to this past Monday (11/12/2018).
So, looks pretty normal. Even with the big moves in the past few weeks, nothing out of the ordinary here. In fact, I would have guessed things were pretty wild since Trump was elected, but if you look back to even 2012, 100-day vols have been in a normal range. It certainly doesn't feel that way.
OK, so maybe vols don't tell the whole story. Let's look at some other things.
We've had a few days where the market was down more than 2% recently. Or it feels like it happens a lot. So, I looked to see how often the market went down more than 2% on the day. To make it a readable chart, I just summed up how many times the market declined by more than 2% in the past 200 days.
Here's that chart:
So yes, it's a little elevated, but nothing really out of the ordinary. Look at the period during the crisis! Also, look at the mid to late 1990s, even before the bubble collapsed.
What about those days the market opens down 800 points and closes up 300, or some such crazy thing? It seems like that sort of thing happens a lot these days. If I had to guess, I would tell you that that happens more often these days than in the past.
To measure that, I just subtracted the day's high from the day's low and divided it by the day's close, and then took a 100-day average of that.
Here is that chart going back to 1962 (hi-lo data only goes back to 62):
...and surprisingly, this too is in a very normal range, and far below the levels of even the mid-90s (I guess the day traders used to make this really wide). Nothing out of the ordinary here.
And let's look at the number of days in the past 100 days that the day's range exceeded 2%.
Totally normal range. Nothing out of the ordinary.
Conclusion JPM is now a BRK stock. Get Jamie on the board! He would be the person I trust most next to Buffett.
BRK scores low on corporate governance, but so what? Look at the incentive structure, which is more important than committees, bureaucracies like compliance/legal departments etc.
People who write to complain about BRK are people who just don't understand, or just use BRK to grandstand and gain attention by making astounding claims against consensus (this is why people like to say "the market is going to crash 50%!", or "the market will get to 500,000!"). So ignore those people.
Microsoft is pretty awesome. I never made a post about it as an investment; I should have when I started to get interested, but oh well. Maybe eventually, but I don't really have anything to add to MSFT in terms of financial analysis/valuation.
And, the markets seem like they are crazy and more volatile than ever, but the above charts don't bear that out. People, the press, keep freaking out over 2% moves as if they are 10% moves. The markets, despite all the things that should make markets more volatile than ever, are just as volatile as they ever were and no more. So relax!
Wow. Apple (AAPL) was a $28 billion position at the end of 2017, with 167 million shares, but now BRK owns 252 million shares as of the August 13-F (November will be out soon), for a position size of $47 billion then and $52 billion now (as of 11/4/2018).
That sounds crazy as it's the largest position ever, and it's a 'tech' company. OK, maybe it's a consumer products company and not a tech company. Either way, wow, that's a big bet, exceeding 10% of the market cap of BRK. Well, for focused investors, 10% is not such a big deal, and even 25% of the equity portfolio may not be that crazy as AAPL isn't some obscure micro-cap, or over-leveraged industrial cyclical or anything like that.
But, I am not the biggest fan of AAPL, so it is interesting. Coming right off his IBM miss, I guess many shareholders would be a little surprised.
Of course, I don't recommend it, but this is an easy position to hedge against; you can just short AAPL shares against whatever BRK owns.
Here is the 13-F from August; I only show positions of more than $10 billion here:
You can get the whole sorted table here. (oops, the above link shows an error for some reason. You can click 'website' below and then just go to the 13-F section and click BRK).
I know a lot of stuff on the website is broken. When I have time, I will fix it and maybe add some stuff to it. When Google finance/Yahoo finance dropped their financial data API's, a lot of things broke and it got to the point where I would have to pay for data to update stuff, and I don't want to do that. I recently noticed that a form of the Yahoo Finance API is back up, so I will be able to update some stuff, but I will have to rewrite a lot of the code, so I am in no rush to do it at the moment (I have a lot of work I need to do for others etc... this stuff goes to the back of the queue, unfortunately).
The bull and bear argument has been the same for years, so I don't want to get into it again here, but I feel like AAPL has sort of been chasing the crowd lately rather than leading it or disrupting it like they used to during the Jobs years. But again, this would get the AAPL fans all fired up and angry, so maybe I'll leave it at that. I'll just say that moving up to higher end products to make up for declining growth momentum reminds me of retailers/restaurants that hid declining traffic/unit volumes by moving up-market or raising prices. It works for a while until people finally say, no mas, and will no longer pay high prices. Sort of reminds me of J. Crew, P&G etc.
The Markets The markets have been going nuts too. Well, I don't mean to imply that Buffett has gone nuts, really. AAPL has a strong brand name/franchise, high returns on capital, decent margins, too-strong balance sheet, repurchases a lot of shares etc. So a lot of the boxes are checked in this case. Can't blame someone for buying a company like that.
The markets can be down hundreds of points overnight, but then be up hundreds by the close (if not an hour after the open), and vice versa. It has always been meaningless to stare at the market during the day (and futures overnight), but it seems even more so these days. I guess bots can be part of it. Risk parity is probably also a part of it. Leveraged ETF's. In any case, it's important to remember that we shouldn't be responding to markets. You should never be selling anything when the market is down 800 points. That's just obvious. If anything, if you have something to buy, you should be buying. But if you sit there and stare at the markets or otherwise follow it too closely, all sorts of bad thoughts can go through your mind. If it is too upsetting or scary, just turn off the TV, or don't look at the market for a while. It's like the weather in Amsterdam; if you don't like it, just wait. It will change. (Did I get that right?)
Interest Rates I hear all the time that interest rates are going up so the market must go down, but all of my work in previous bubble posts were based on the baseline assumption that the 'normalized', sustainable long term interest rate is probably around 4.0%. Using a lot of historical data, I showed that if the long term rate averages 4% over the next 10 years, the market could easily average a P/E ratio of 25x over that time frame. This is not a prediction, of course. It's just an observation based on history: if it's not different this time, and if interest rates average 4% over the next 10 years, then, based on history, a 25x P/E would be completely normal.
Yes, this is basically the Fed model, which has been a subject of debate if not completely discredited by some. One debate is that the relationship between P/Es and interest rates held only for a brief period in time and not for the whole 100+ years of recent history, but my feeling is that since interest rates were regulated for much of the early 20th century, it's hard to say if there is any meaning in the lack of correlation going too far back in history. The other argument is that P/E or E/P is 'real' whereas bond yields are not. But this argument only strengthens the above argument. A low E/P is even more attractive than a low bond yield as the E will increase with inflation whereas the bond yield will not. And comparing earnings yields to the TIPS yield (which would take care of the real versus nominal problem) would just be silly as the TIPS yield 10 years out is 1.2%, suggesting a P/E multiple of 83x.
So, watching the market throw conniptions because interest rates went above 3.0% didn't worry me at all. I thought, OK, well, whatever. All else equal, higher rates may equal lower equity prices, so people dump stocks when rates go up. But as I've said in my bubble posts, I don't see the rubber band stretched at all, so the market is not in need of a violent correction. Of course, if we are on our way to 6-8% long term rates, then that's a different story.
Hedging When markets go crazy like this, people tend to ask me about hedging. Well, first of all, hedging is something to do before the market goes down, not after. It's interesting that people start to want to hedge after the market starts to go down and volatility goes up (hedging costs go up).
I've spent a lot of time in the derivatives business, and a lot of it is about hedging. There are a lot of good and valid hedges; interest rates, FX, commodity prices etc. But when it comes to the stock market, a lot of hedging is baloney. Some large institutions may use futures to synthetically adjust their asset allocation (sometimes cheaper than selling stocks, paying taxes and buying something else).
But when it comes to just directional hedging of the stock market, I think more money has been lost trying to do that over the years than any money actually lost in the stock market. I know for sure that if you try to hedge a stock portfolio with futures, options or swaps, it's going to cost you. If you need to hedge your portfolio using any of these, most of the time, you are just better off lightening up your position and forget about hedging. If you feel like you need to hedge your portfolio with put options, you probably just own too much.
If you hedge all the time, it's going to be very costly. I'm not going to do it, but just go look at some put option quotes on the S&P 500 index, for example. And imaging rolling that over every three months, or every year. It is not cheap at all. And if you think you can time it and put on hedges only during risky times, well, that usually doesn't work out either. Some very good investors thought the market was expensive a few years ago and hedged their portfolios and it was a disaster. Even the smartest can't time their hedges.
If you look at how wealth is built up over the years, most of the time, it's been created by people who hold very good assets for very, very long periods of time. Nobody gets rich by being very good hedgers of their portfolios. OK, there are some hedge fund managers who have done it over the years, but that's pretty rare. Most other people, if you look at the richest people list, just own good assets and don't try to get in and out according to how they feel about the market or the economy.
In a sense, people like Buffett and Bill Gates are kind of lucky in that they can't get in and out of their positions anyway, even if they wanted to. Imagine Gates calling Goldman Sachs, "I want to put on a zero-cost collar on Microsoft because I don't like where we are going in this economy!". Nope. Won't happen. I know hedging CEO holdings used to be a big business for derivatives desks a while back; maybe it still is. But if you look at the guys who create tremendous wealth, most of the time, they just own and hold onto great assets for long periods of time.
Real estate wealth is built the same way (but they get leverage, and their buildings are not marked to market so they never get margin-called; that's a huge advantage versus leverage in the stock market). They can't just buy and sell futures, options or swaps against their holdings. And they can't trade their buildings short-term either.
As I've said before, the stock market suffers a sort of "curse of liquidity". Since you can just liquidate your entire portfolio by pushing one button on your iPhone (OK, well, maybe not some rich people, but many of us can...), it is easy for us to do stupid things. And you can see how much you are losing every second of the day on your iPhone. You can't do that with real estate; there is no way to tell exactly what it is worth until you put it on the market and get some bids. In other words, there is no manic-depressive Mr. Market knocking on your door every micro-second in real estate (unlike stocks) tempting you into doing stupid things. So 1. there is no stupid-behavior-inducing signals (crashing prices) and 2. there is no way to act immediately on impulse in the real estate market. Most people would do better in the market if they treated their equity portfolio like their home.
GE What a total disaster GE is. I've always admired GE and it was one of those companies that I really wanted to like and wanted to own, but it never quite worked for me. First of all, Jeff Immelt must be the worst CEO of all time. OK, there are CEOs that bankrupted companies, committed fraud etc. So in that sense, maybe he's not the worst. But as a non-criminal, blue-chip CEO, he's got to be one of the all-time worst. And it's not just about the stock price; the businesses are just horrible. It looks like he stood up and got hit with a left hook, ducked to avoid the next shot only to get a big upper-cut to his chin. Whatever he did seemed just wrong.
I remember when Buffett was talking about CEOs, and this was around the time that Irene Rosenfeld sold the frozen pizza business for cheap and overpaid for Cadbury. He was talking about how many CEOs are great operators but many have issues with capital allocation. We all thought he was talking about Rosenfeld, but it didn't occur to me that he was probably also talking about Immelt.
He often said how wonderful Immelt was as a CEO but never actually bought GE stock (or in any size that I can recall; it was never a top holding), and I always wondered about that. In hindsight, well, he was probably also talking about Immelt.
GE is really tempting now at under $10, and the CEO is a really good one, but I'm not sure how GE gets out of this. Frankly, I haven't taken a close look at this in a while; maybe I will. If I find anything interesting, I will probably make a post here. But I just don't like (and never liked) the businesses these guys are in. It's mind-boggling how Immelt just seemed to run the other way than the world was moving.
Has Buffett Lost His Mind?! OK, so back to Buffett. Has he lost it? Is he buying more AAPL shares? Does he need intervention? Should he undergo some tests to make sure he is OK?
I have no idea. I'm sure he is fine, and all accounts (from the annual meeting etc., and is interviews on TV) seem to indicate he is fine.
I guess AAPL is so big because it's the first time in a long time that he really got to like something and it was large enough so that he can actually buy a ton of it. Remember, he was capped at 10% on Wells Fargo due to bank regulations.
I own BRK, and I don't really like AAPL, but I'm not going to hedge out the AAPL piece.
It's been pretty quiet around here. This post has been sitting in the queue for a long time, so I figure I'll just get it out now.
Things seem to be pretty fully priced. When I first started this blog back in 2011, banks / financials were cheap, analysts were bearish, the public hated banks (well, they still do) and Occupy Wall Street was in full force. That was one of the reasons I started the blog in the first place, to say that not all banks are evil, and no, banks aren't dead etc.
Market I still feel the same about the market as I've been saying for the last couple of years. I am not really bullish or bearish, but I have no problem with valuations and don't really see a bubble, except in certain areas.
Yeah, it was scary when the market was down more than 1,000 points earlier this year. But I was not really all that worried. If this is a bubble and a top, it's one of the most timid bubbles of all time. At least that's what I think. Most bears talk about how much the stock market has rallied since the low, and I think that is nonsense.
If a stock goes from $100 to $50, and then back up to $100, is it really overbought? It might be. But not necessarily. If you look at previous bubbles, markets appreciated a LOT from the previous high. In this case, we are not that far above the 2007 peak.
Anyway, that's my view. I know many don't agree, but who cares, really.
Also, people seem to be freaking out that interest rates are rising. But all my bubble posts used 4% as the 'normalized' long term interest rate, and the market is not expensive, in my mind, even with interest rates at 4%, let alone 3%. So that, to me, is not yet a big concern. Of course, interest rates can overshoot due to higher than expected cyclical inflation. But that doesn't really concern me all that much. Sure, the market will tank on each interest rate uptick, but since the rubber band is not that stretched (in terms of the relationship between P/E and interest rates), there is no need for the market to go down all that much.
Buffett also keeps saying that stock market valuations are driven by interest rates. Critics say comparing earnings yield to bond yields is wrong as it compares 'real' versus 'nominal'; bond yields don't adjust to inflation but earnings yields do (over time as earnings will increase with inflation). This is true, but if you make that argument, then maybe earnings yields have to be compared to the TIPs bond yields, which is 'real'.
10-year TIPs yields around 0.9% these days, so to compare real-versus-real, the stock market should be trading at 111x earnings. But don't forget, company earnings grow with the economy over time and not just with inflation, so stocks still have a 2% or so advantage over TIPs even at 111x P/E.
But of course, this is all just theoretical mumbo-jumbo. I wouldn't tell anyone with a straight face that the market should be trading at 100x P/E. I wouldn't pay that either, and if the S&P 500 index was trading that high, even I (the avid non-market-timer) would be long a boatload of puts!
Buffett I watched the annual meeting and his long interview on CNBC and it was great as usual. But honestly, I don't remember the last time a question was asked and the answer wasn't something I would have guessed. The letter to shareholders too was the usual, and like others, I was surprised at how short it was. He is getting old so regardless of what he says, he is probably slowing down a little.
What might happen, and might be really cool, is if others contributed to the letter. Maybe Todd/Ted/Ajit /Greg can contribute a section in some way. That would be interesting, and would be a nice transitional thing to do.
Privacy/Facebook: The latest thing in the press is about Facebook and privacy. One thing I don't understand is that when we joined Facebook, we sort of all assumed we will have no privacy there. That's why I don't have my real birthday there, no credit card information nor my social security number. I remember upsetting some people when I didn't put my real photo on the profile page. Well, my fear was that not too far in the future, people would be walking around with something like Google Glass, and they will know immediately who I am because of the facial recognition app that will no doubt be installed on it. The glasses will automatically see my face and do a search, find my image and profile (either from Facebook, Google+, LinkedIn or wherever.
If you are tagged even once on a public photo, the engine will be able to identify you anyway, even if your profile photos show a picture of Dexter Morgan. Once they know your name, the app will search through Linkedin, find out what you do and then maybe scan Glassdoor to estimate what you make etc... All of this will show up on the glasses, and will do so for anyone that is looked at. Creepy stuff. But that day is inevitable, I think. One day the IRS will get hacked; you will be sitting in the subway with your hi-tech glasses and look around and you will see the tax returns of every face you focus on. This is certain to happen, eventually. I have no doubt about that. This is the sort of thing that scares me. (but then again, I have nothing to hide, so I don't really care. It's just creepy)
But anyway, I was kind of surprised at all this outrage about FB; what did people expect? You fill out a questionnaire or do those silly trivia games and are shocked that someone is using that data?!
Actually, it seems like it is not affecting too many people, so maybe it's just the press going crazy over it and making more of a big deal out of it than your average FB user.
I still think mobile phone companies and credit card companies know far more about you than FB; those guys know where you are, what you spend money on going back decades etc. Creepy. But that's been true for a long time.
JPM Anyway, as usual, the JP Morgan annual letter is a great read. No need to elaborate much on it, but as usual I love the charts they put in it and in the proxy. These are charts I've been following for years, even before they started to put them regularly in the reports.
Conference call By the way, I usually listen to the JPM conference calls every quarter. There is a lot to learn from them, and when Dimon is on, he is usually pretty blunt, so fun (and educational) to listen to.
But one thing that I wonder about is the format. When you listen to some of the high-tech conference calls, what's cool is that some of them totally drop the summary and go right to Q&A. Do we really need someone to read off the highlights from each slide? I would rather that be cut and have a longer Q&A session, or have topics not covered in the slides. It seems kind of silly that someone just reads off something we all have already.
Amazon's meeting protocol is interesting. I think they spend 20 or 30 minutes reading the material (at the meeting) before they start discussing stuff. Obviously, there would be no need to have a conference call and be silent for the first 30 minutes... Maybe just release the documents 30 minutes sooner or whatever (I know they release it before the call, but just increase the time in between, maybe). Give people time to go over it so on the conference call, they can just focus on the Q&A, and maybe a short comment just highlighting important things.
But I don't know. Maybe the analyst community likes it that way as they have to sit through a bunch of these during earnings season and they like that slow time in the beginning so they can flip through the slides etc. But for others, it's a tedious section to sit through...
Bitcoin I haven't changed my mind about bitcoin at all, and no, I haven't gone out and secretly bought some "just in case". Nope. Didn't do that and don't plan to. I continue to side with Buffett on this. And he had a good point in the interview/annual meeting: these things with no intrinsic value and where people can only make money if more people come into; people get angry when you speak out against it as they need people to come in for the price to go up.
I remember the anger and emotion when people spoke against gold too. But you never really see value investors get upset when bears talk down value stocks.
Hedge Funds What's up with these big hedge funds? I don't know. I am a fan of the big hedge funds, generally, but many have been doing horribly in recent years. I am especially shocked how bad Einhorn is doing, as he seems to be making the same mistake that the big funds made back in the 1997-2000 rally. If you remember, guys like Julian Robertson and Stanley Druckenmiller had trouble back then, as shorting expensive stocks and buying value didn't work for a few years back then. One would think people wouldn't repeat that mistake, and yet, Einhorn is short a bubble basket.
Anyway, his analysis is probably right, and those stocks will probably go down or be valued more realistically at some point. But the problem is you could have argued that with Amazon and Netflix for years. Who is to say it has to 'normalize' within the next twelve months? And if it doesn't, the stocks can be up another 30%, 50%, or 100%. If the market is ignoring fundamental valuation, that just means something trading at 100x P/E can just as easily go to 200x P/E. Why would you want to get in front of that!? I don't know. But these guys are way smarter and richer than me, so who am I to say.
Average Holding Period of Stocks People often talk about the average holding period of stocks, and how that has been shortened dramatically. I tend to think that analysis is flawed, as many of those figures use trading volume as one of the factors. Well, with all that HFT trading going on where portfolios can turn over 100% in minutes, that sort of skews the data. Just because a bunch of quants start trading with average holding periods in micro-seconds, that doesn't really affect the rest of us who still like to own stocks for 5, 10 or 20 years.
But anyway, not a big deal.
Ian Cumming/Leucadia I realized way after the fact that Ian Cumming passed away earlier this year. I don't go to many annual meetings, but I will never forget the last LUK annual meeting with Cumming/Steinberg. I wrote about it here.
Not long after that, Leucadia changed it's name to Jefferies Financial Group and ticker symbol back to JEF. Oh well. I guess that reflects the reality that LUK is not really LUK anymore (and wasn't after the merger).
JPM OK, so most of these are self-explanatory but let's look at some of the charts from the JPM 2017 annual report.
JPM is doing well against comps in terms of cost and return on tangible book.
Classic Dimon; snip from annual report:
I was recently at a senior leadership offsite meeting talking about bureaucracy. We heard bureaucracy described as “a necessary outcome of complex businesses operating in complex international and regulatory environments.” This is hogwash. Bureaucracy is a disease. Bureaucracy drives out good people, slows down decision making, kills innovation and is often the petri dish of bad politics. Large organizations, in fact all organizations, should be thought of as always slowing down and getting more bureaucratic. Therefore, leaders must continually drive for speed and accuracy to eliminate waste and kill bureaucracy. When you get in great shape, you don’t stop exercising.
Meetings. Internal meetings can be a giant waste of time and money. I am a vocal proponent of having fewer of them. If a meeting is absolutely necessary, the organizer needs to have a well-planned, focused agenda with pre-read materials sent in advance. The right people have to be in the room, and follow-up actions must be well-documented. Just as important, each meeting should only run for as long as it needs to and lead
I love these two quotes. I worked at a large company and it's so true. People tend to spend more time building and defending bureaucracies than building businesses at big places. Dimon talks about having war rooms to tackle urgent issues. Part of why that's so great is because the teams are put together for specific projects, and are presumably disbanded after the task is done.
The problem with big companies, oftentimes, is that a section or group is set up to deal with certain issues, but when those 'issues' are resolved or are no longer issues, the group or department, have to invent other reasons to keep existing. Or sometimes they don't even have to do that; the department survives with underemployed people doing nothing all day long (I have seen this). They can't shut down these divisions because there is no place for the managers to go, and they can't be demoted. With ever expanding companies, this is an issue as you have to sort of create more and more of these divisions that worthy employees can be promoted into.
There probably shouldn't even be departments/divisions at all. Teams should just exist temporarily for specific tasks and that's it. Once you create a department, it just creates incentive for the head of that department to get bigger, and of course, they will resist change when the environment changes. So ban divisions!
But of course, that's easier said than done. I am not a manager, so it's easy for me to say!
1 TSR assumes reinvestment of dividends
The Firm has demonstrated sustained, strong financial performance
We have generated strong ROTCE over the past 10 years, while more than doubling average tangible common equity (“TCE”) from $80 billion to $185 billion, reflecting a compound annual growth rate of 10% over the period.
We have delivered sustained growth in both TBVPS and EPS over the past 10 years, reflecting compound annual growth rates of 10% and 19%, respectively, over the period.
ROTCE and TBVPS are each non-GAAP financial measures; for a reconciliation and further explanation, see page 115. On a comparable U.S. GAAP basis, for 2008 through 2017 respectively, return on equity (“ROE”) was 4%, 6%, 10%, 11%, 11%, 9%, 10%, 11%, 10% and 10%, and book value per share (“BVPS”) was $36.15, $39.88, $42.98, $46.52, $51.19, $53.17, $56.98, $60.46, $64.06 and $67.04.
Excludes the impact of the enactment of the Tax Cuts and Jobs Act of $2.4 billion (after-tax) and of a legal benefit of $406 million (after-tax). Adjusted net income and adjusted EPS are each non-GAAP financial measures; for further explanation, see page 115.
Anyway, there is not much more to say about JPM than to say that they continue to be doing really well. Their performance since 2008 is amazing no matter how you slice it; who would have guessed this performance back in 2008 as the financial market started to melt down?
I know I spent more time talking about random stuff than JPM, but whatever... I just want to get this out now so...
I love books, and out of all the retailers out there in the past five, ten years, I've spent more time at BKS than anywhere else. It used to be Tower Records or J&R Music World, but now that they are all gone, BKS is one of the only other retailers that I actually enjoy being in (and, of course, some independent bookstores).
Bitcoint tangent By the way, I don't care, really, either way about bitcoin, but did you guys notice something really interesting? The financial guys that really love bitcoin are some of the guys that either blew up or closed funds due to poor performance. The two most prominent fund manager bitcoin boosters are like that. It almost feels like they are so happy to have found their Hail Mary pass. And the most prominent guys that have good performance and didn't blow up tend to be the guys that don't like bitcoin and think it's stupid, a bubble or whatever.
Think about that for a second. Oh, and that former hedge fund guy, after bitcoin plunged put his new bitcoin hedge fund on hold (buying high and selling low?). Now wonder he didn't do well with his hedge fund; if you're going to be making decisions based on short term volatility like that, you are bound to get whipsawed and lose money.
This is interesting because we can never really understand and know everything. But it is useful to know who you can listen to and who you should ignore. Sometimes, this saves a lot of time!
Back to BKS But what has been shocking to me, after having spent hours at BKS over the past few years, is how inefficiently run it seems to be. I am always surprised at how many employees there are walking around, or just standing there doing nothing at all. I'll call them floaters. Sometimes, desperate looking employees come up and ask me if I need any help as if they have to fill a quota on how many people they help.
Recently, even before the holiday rush, I saw two BKS employees leaning against the hand-railing playing with their phones. I went to look for some books, came back, and they were still there. Doing nothing at all; not even greeting.
And what about those 'greeters' at the top and bottom of those escalators? They remind me of the Japanese department stores in the 80's; those uniformed employees with handkerchiefs held against the escalator handrail, bowing to customers as they get on and off. Yes, BKS has the equivalent of that, in 2017! Sometimes they stand so close to the escalator that it seems dangerous as it blocks people from getting off... I almost tripped when someone stopped right at the top of the escalator to ask a question. Last fall, I saw two people at the bottom of the escalator. Do we really need so many greeters? (and why are they all white?! Even in diverse Brooklyn, all of the employees are white, except for security guards and cleaning staff. Is BKS so old-fashioned to think that only white people have college degrees and are capable of working at BKS? This is 2017, not 1830. Come on!).
With 600+ stores, these greeters and floaters can be very costly. I can't imagine them making less than $15/hour. At 8 hours a day and 600 stores, one of those floaters (I call them that because they just float around doing nothing) can cost the chain $26 million/year. You get two of those, and that's $50 million/year.
To put this into context, the bookstore (excluding NOOK losses) had operating income of $91 million in 2017 (ended April 2017).
Of course, this may be a little too simple; not all stores will have elevator greeters etc., and operators will point to K-Mart/Sears as an example of what would happen if you cut too much in costs (and how financial people are clueless). But that's an extreme case, I think. It doesn't mean there isn't room for improvement at BKS. I know that they respect their 'booksellers' and want that community bookstore feeling with tons of friendly and knowledgeable employees to help people buy books. But it seems a little over the top and outdated to me. But I'm not a retailer so...
Technology The other thing is that when you walk into a BKS, it's like walking into the 1970's; there is no technology anywhere. OK, there probably is in the POS system and in the back somewhere, distribution etc. But otherwise, the absolute lack of technology is kind of stunning.
Japan is not known for running efficient retailers (there are some good ones, like 7-11, Uniqlo, Muji etc.), but even in Japan there was this cool thing at a large bookstore:
It's a section where customers can search for things on their own. At BKS, when you ask someone anything, most of the time they go to a machine and do a search. I always wish they had one available for customers so we can do it ourselves. It would free up a lot in terms of labor. Even the New York subways have huge touch-screens so you can find and get information.
Here's the other thing. I notice long BKS checkout lines and wonder why that hasn't been automated. I would think books, due to their relative uniformity, would be the easiest product to implement self-checkout.
And here's the embarrassing thing; even the public libraries have self-checkout now. I love the public libraries and don't mean to knock them, but you don't expect those quasi-governmental, non-profit organizations to be at the forefront of technology. Those self-checkouts are really great. I used to hate waiting in line to check out books at the libraries. Now it is very easy and fast. And self checkouts would mean noone trying to sell you anything! I used to always have this awkward conversation, saying no, I don't need a card, and no, I don't want you to have my email address or mailing address etc...
Also, most of the time when you see someone ask a BKS employee a question, it's "where are the cookbooks?" or some other thing. Any high school coding club could set up a touch screen floor-map of a store pretty easily. I always wondered why there isn't one of those set up by the front door, elevator and escalators. Technology is getting cheaper and cheaper. And BKS seems to be one of the best places to implement some of this stuff. They also have so much data that they would be able to use (just saving what is searched by customers would give a hint to buyers).
Pricing The other issue is pricing. Even if you are a member and get a 10% discount, the prices on most books are still much higher than on Amazon if you are a prime member (and get free delivery). Amazon built their business on the Costco model, but BKS memberships seems like a half-hearted attempt at that. There doesn't seem to be a real economic benefit to being a BKS member (if AMZN books are still way cheaper than BKS member prices, why bother?!).
If they are going to do it, why not jack up the membership rates and lower member book prices? Why not match online prices like Best Buy? (isn't that how BBY recovered?). Anyway, I don't know. It's really frustrating to watch this ice cube melt as I really do like BKS and don't want them to go under. But if they keep their head in the sand and try to keep up with this, they are not going to survive, and that would be a bummer for me (where would I hang out in a mall or when I have to wait for someone when they shop?!).
There are a bunch of other things, like, why is their CD/DVD section still so big, and prices so high? Do people actually buy things there? Every time I see those sections, I walk through it and I don't think I've ever seen anyone in there. I saw very few people in there during the holiday season, but usually it's empty or one or two people at most... What's up with that?
I know retailers are dangerous for private equity and activists, but it just seems like there is so much low-hanging fruit there that I can't imagine someone not making money off of gaining control.
Having said that, I don't own any (and have never owned) shares, yet. It is definitely a melting ice cube so I would be careful. But still...