Knowledge grows through sharing! To be the best, learn from the best! May all your dreams come true! Collections of Value Investing articles, interviews and videos, especially on Warren Buffett and Charlie Munger and articles from various disciplines to build "Latticework of Mental Models"
Our situation is dire. Moderate booms and busts are inevitable in free-market capitalism. But a boom-bust cycle as gross as the one that caused our present misery is dangerous, and recurrences should be prevented. The country is understandably depressed -- mired in issues involving fiscal stimulus, which is needed, and improvements in bank strength. A key question: Should we opt for even more pain now to gain a better future? For instance, should we create new controls to stamp out much sin and folly and thus dampen future booms? The answer is yes.
Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct. And only when there is strong public revulsion, such as exists today, can legislators minimize the influence of powerful special interests enough to bring about needed revisions in law.
During her presentation, Schroeder provided a fascinating case study of a private investment Buffett made in 1959 in a company called Mid-Continent Tab Card Company. At the risk of sounding technical, tab cards were something used in computers back in the day. At any rate, with over 50% profit margins, selling tab cards was IBM’s most profitable business in the 1950s. As a result of a settlement with the Justice Department, IBM was forced to divest of its tab card business. A couple of Buffett’s friends, Wayne Eaves and John Cleary, had started a tab card company themselves in the mid-to-late 1950s. It was an extremely profitable business. Tab cards were made on what was called a carel press. They were turning their capital over 7x per year while earning 40% net profit margins. In 1959 they were looking to grow this profitable business which required buying more carel presses.
So, in 1959 Eaves and Cleary approached Buffett to see if he had any interest in investing in the company. This is where Schroeder’s presentation gets interesting as she describes the process Buffett went through in deciding if he wanted to invest in the business and the return criteria he desired for putting up the money. I suspect the first thing that most analysts would do when presented with such an investment opportunity is to ask for management’s financial projections and then create a discounted cash flow model. According to Schroeder, Buffett did none of this. In fact, given complete access to all of Buffett’s files, she never once saw anything remotely resembling a financial model. Instead, he analyzed on a quarter-by-quarter and plant-by-plant basis, the historical profit and loss statements for both Mid-Continent and all relevant competitors. From there he acted like a horse handicapper figuring out which one or two factors would make the horse succeed or fail. In the case of Mid-Continent it was sales growth and cost advantages. When presented to Buffett in 1959, the company had $1 million in sales, was growing at 70%+ per year and earning 36% profit margins. According to Schroeder, the ultimate decision to invest came down to the question, can I get a 15% return on $2 million of sales. The answer in his mind was yes, so Buffett invested $60,000 of his non-partnership money representing 20% of his net worth. This investment gave him 16% of the company’s stock plus some subordinated notes.
As one would expect the Mid-Continent investment turned out quite well for Buffett. Over time he put another $1 million in the company, which would later be renamed Data Documents. The company was sold in 1979 to Dictograph. Buffett held the investment for 18 years earning a 33% compounded annual return…sign me up!
What was interesting to me from this case study was that he did not seem to bother himself with projecting revenue and profits out five years, did not grind over whether to use a 10% or 12% discount rate, nor worry about which terminal multiple to use. There certainly was no investment banker’s “book.” Instead, he approached the investment wanting a 15% “equity coupon.” From there, he had to decide for himself whether it was a cinch to get such a return while relying solely on analyzing historical profit and loss statements.
He is a little bit greyer than he was before the beginning of his biblical seven lean years, and a little bit balder, and slightly more wrinkled, but wiser, too. He has learned. He has discarded one of his own personal commandments, a rule he rarely breached in 20 years: Thou Shalt Not Give Interviews to the Press. He has opened his mind and his mouth to journalists, analysts, skeptics and enemies. He has a PR agent now. He does conference calls and takes questions. He has done all this because he had to--because his life's work was attacked, and because it became clear to him that the world had changed, and it wasn't good enough any longer to stay cloistered in his comfortable circle of friends and admirers and confidants and fellow travellers.
But that doesn't mean he likes it. And it doesn't mean he wants the attention any more than he did a decade ago, before all the trouble started, when he was still labelled a "recluse" and Bay Street loved him and his peculiar creation, insurance and investment company Fairfax Financial Holdings Ltd. Over the decades, The Globe and Mail has named dozens of CEOs of the Year. Prem Watsa is the first, as far as anyone can recall, who tried to reject the honour. Vehemently.
It's Fairfax policy to reject all awards to individuals. In 1999, Watsa even turned down a business leader award from his alma mater, the Richard Ivey School of Business; other Fairfax executives have rejected similar nominations. Watsa would not pose for photographs or grant an interview for this story (though he has given several interviews to The Globe this year, most recently in early October, when he spoke at length about the financial crisis and predicted a long, deep and painful recession). Through the company's chief legal officer, Paul Rivett, Watsa asked us to rename the title "Company of the Year" and grant it to Fairfax instead of him. He even offered to try to find us a more willing candidate. These efforts were not an act of false modesty. In Rivett's Toronto office, there is a limestone plaque that reads: "There's no limit to what a man can do or where he can go if he doesn't mind who gets the credit" --a quotation often attributed to Ronald Reagan. Watsa gave one to all senior Fairfax executives.
Well, tough luck, fella. Sometimes you have to suck it up and accept the credit. And this year--the most extraordinary year in financial markets since the Depression--is unquestionably Prem Watsa's time. His critics, the so-called cadre of hedge funds and their hired hatchet men whom Watsa alleges tried to destroy Fairfax in 2005 and 2006, are in retreat. The very practice of short-selling, while hardly discredited, is under scrutiny now, as are the practices of the brokers and traders who serve short-sellers. An analyst who helped touch off panic selling in Fairfax shares--by writing a report that essentially claimed the company was on the road to bankruptcy because it had failed to set aside a necessary $5 billion (all currency in U.S. dollars) for insurance claims--has been fired for leaking that document to some clients before its release. Fairfax seems financially healthy for the first time since Monica Lewinsky was on everyone's lips. In the summer, Moody's Investors Service raised Fairfax's credit rating, which it hadn't done since 1998; DBRS Ltd. moved the company's bonds to investment grade, where they hadn't been since 2002.
But these are mere details. The real reason Watsa is the (reluctant) recipient of the title is that, in three words, he called it. He didn't know that the greatest financial disaster in decades would unfold in the autumn of 2008, of course, and he didn't predict that it would sink such leviathans as Lehman Brothers and American International Group, his biggest rival in insurance. But he did spot the source of the trouble long before most everyone else. And he has $2 billion to prove it.