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New opportunities, Timeless Principles.
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Beyond Buffett
Buffett does not invest in the technology
companies or international companies or
small (public) companies because they are
outside his circle of competence; his tenets
can be applied to investing in any company,
any industry, any market.
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Application in other areas
Technology companies Small companies International stocks
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What are the problems?• Less certainty
Solution• Higher margin of safety
• Buy less (as a percentage of your wealth)
Hagstrom sees?
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How do the big 12 fit? Small-Tech-Int’l
Simple/understandable? Consistent operating history? Favorable long-term prospects? Rational management? Candid management? Resist herding?
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How do the big 12 fit? (The sequel)
Focus on ROE, not EPS? Calculate “owner earnings” High profit margins? A dollar retained → A dollar market value? Determine value of business Can purchase at discount?
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Bill Miller – Technology stocks
CEO Legg Mason Funds and Manager of Value Trust
Profiled as one of the five heroes of value investing.
Adapted Buffettology to investing in the New Economy stocks (Recall Level 3)
http://www.leggmason.com/funds/ourfunds/managers/bill_miller.asp
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The Sales Pitch At the end of 2003, Value Trust became the only fund
to have outperformed the S&P 500 each of the past 13 calendar years. Keep in mind that past performance is no guarantee of future results.
“I am confident the bear market is over and that the probabilities favor much better results than we experienced in the past five years…Whether…provisional beliefs turn out to be true, please be assured that no one will work harder or care more about your money than the Value Trust team.”– Bill Miller, Portfolio ManagerApril 19, 2004
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Value stocks
Low Market-to-book ratio.• Market Price / Book Value
Low Price-to-Earnings ratio.• Market Price / EPS
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Miller’s argument
This line of thinking is flawed because value does not depend on market price, it depends on the future cash flows.
The trick is value the future cash flows rationally and buy them at a big discount.
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What is different about tech co.’s• Uncertainty.
• High M/B and PE ratios.
Do sensitivity analysis. Keep higher margin of safety. Invest a lower percentage of your wealth.
So did we get them all?
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What is similar about tech?
• high profit margins,
• high returns on capital,
• the ability to reinvest the profits back into a fast-growing company, and
• management that acts in the interests of shareholders.
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The Franchise Factors
“Yes, people are still buying Coca-Cola and Gillette
razor blades, and using their American Express Card,
but they are also using America Online, and Microsoft
software, and buying Dell computers – and that’s
ubiquitous.”
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The Franchise Factors for Tech Network effect
• “Everybody I know is on AOL…”
Positive feedback
Lock-in• VHS technology and Computer Keyboard.
Increasing returns• Low capital expenditure is needed to increase sales.
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Case Study: AOL and the Buffett Tenets
Simple and understandable? Yes.
Consistent Operating history? No, new.
Favorable long-term prospects? Yes.
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Rational management? Yes.
Institutional Imperative? Yes.
Candid management? Yes and No.
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ROE?
High profit margins? Yes.
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What is the value? In 1996, Bill Miller calculated it to be $7.5 billion as compared to the market price of $4 billion.
Discount? His average cost is $1.75 as compared to a market price (after a steep fall) is around $17.
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AOL and the Technology Franchise Factors.
Network effect -
Positive feedback
Lock-in: flat rate.
Increasing returns.
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Smaller and Mid-Cap Stocks
Why Buffett does not invest?• Too small for his big pool of funds.
• Market impact
• Lack of liquidity
• Will invest if can buy “whole” business
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Wally WeitzWallace R. Weitz & Company (Estd. 1983)
Mid-cap funds
• Weitz Value Fund
• Weitz Partners Fund
Small-cap fund
• Weitz Hickory Fund
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Similarities with Buffett
Both operate from Omaha, Nebraska.
Weitz tries to determine what a rational buyer would pay if that buyer had the opportunity to purchase 100 percent….
Does the company have some special market niche, or a franchise value?
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Like Buffett, he sticks with businesses he can understand.
Seeks businesses that generate excess cash and have honest managers.
Low turnover – 20 to 30 percent per year.
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Small-Cap Companies - Problems
Until they have gained substantial market share,
they are potentially greater economic risks.
Low liquidity
• Require low turnover.
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Advantages
They tend to be less complex, less bureaucratic.
Their managers are often more accessible.
Less covered
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International Stocks - Challenges
They may have different accounting
standards.
There is a risk that the currency will decline
relative to the dollar.
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It is more difficult to interview management.
Political, social and economic turmoil can
ruin companies and swallow the expected
gains.
Why hasn’t WB done much Int’l
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Mason Hawkins, Southeastern Asset Mgt.Longleaf Partners funds.
Concentrate on cash and not the accounting
figures.
Only buy if it is selling for less than 60 cents for a
dollar.
Shareholder oriented “good” managers
Non-diversified investments.
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Hedge the currency risk, add the cost of
hedging at the valuation stage.
Travel to collect the information.
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Essential To Look For – Anywhere, Any Time
“Good businesses that generate great economies
run by smart managers available at cheap prices.”