Thursday, May 11, 2017

Lessons from Omaha - Part 1

A trip to Omaha, Nebraska, USA is like a pilgrimage. Muslims hope to visit Mecca once in a lifetime. In the olden days, Christians went to Jerusalem on crusades. As value investors, well, we should pay homage to the world's greatest investor - Warren Buffett aka the Oracle of Omaha, by going to Berkshire Hathaway's Annual General Meeting (AGM) for shareholders, maybe as many times as possible before things change.

For the uninitiated - Berkshire Hathaway is Warren Buffett's investment vehicle which was a textile company that he bought 52 years ago. It went bankrupt but he used it to invest in other companies which then became the world's largest conglomerate (4th largest company by market cap). Some people ask is it worth making the 30-hour flight just to see him? What's the value add of doing that? What would he say that would be different from what he had said all these years? Isn't the whole AGM already broadcasted live on the Internet? 

Well, we can always listen to Coldplay on YouTube right? Why do we go to Coldplay's concerts? Why do some die-hard fans fly all over the world to every concert venue to listen to them sing the same songs? It is for the experience. To share the atmosphere with like-minded fans. In a way, the trip to Omaha is like going to a live concert. Actually it's more a pilgrimage. It is very difficult for non-investors to understand despite our best effort to explain. But having really made the trip, I have this to say: the trip is worth every effort and I urge every serious investor reading this to try to go while both of them are still alive. Warren Buffett is 86 and Charlie Munger, his Number Two, is 93.

What's there to do in Omaha besides attending the AGM? Before the trip, I was also quite dumbfounded, would it be just attending the AGM and visit Buffett’s house? I was so wrong. There's so much to do! I would say that it might be worthwhile to stay in Omaha for 5 days or so to fully enjoy the experience. The usual affairs would be just 3 days from Friday to Sunday but in order to fully cover everything, we certainly need more days!

Here's a list of Must-Dos:

1. Shareholders' Shopping Day before Berkshire's AGM
2. Eat at Gorat's Steakhouse (Buffett's favourite restaurant)

Gorat's Steakhouse

3. Visit Nebraska Furniture Mart and Borsheim's (both Berkshire companies)
4. Visit Warren Buffett's house and office
5. Go to Markel's AGM (usually the day after Berkshire's AGM)
6. Visiting Nebraska Crossing Outlets (factory outlet with Coach, Kate Spade, Adidas, Nike, Under Armour, North Face etc)
7. Eat at the various other restaurants (Sullivan's, Red Lobster, Five Guys Burger, 11-Worth Cafe, Orsi's Italian Bakery and Pizzeria etc)
8. Shop at the key US retail shops (Walmart, Target, Best Buy etc)
9. Attend other events surrounding the AGM (there are many, some with high entry fees - the key one being the Value Investing Conference which is a few hundred dollars for a dinner but there are also others which are quite affordable)
10. Last but not least, do the 5km Berkshire Run!

Invest in Yourself!

Ok so what are the lessons we can learn from such a pilgrimage? I would put the investing lessons in the next posts, which are some of their thoughts on technology disruptions, good businesses, the state of the economy etc. In this post, I would like to share some life lessons that he and the other speakers talked about. My favourite quote of the week was actually from Charlie Munger. Charlie is pretty much the all-important Number Two without which Berkshire would never achieve what it had achieved. Much like the trusted advisor and architect like Zhuge Liang of the Three Kingdom, Goh Keng Swee of Singapore and Steve Wozniak of Apple. 

When asked what he admired about Warren Buffett most, he said this (I'm paraphrasing him): "Buffett is very much capable of continuous life long learning. He is a learning machine. Years ago he would never have bought Apple. Yet after learning about its products from his grandchildren, he bought it!” You see, in the past, Warren Buffett never invested in tech stocks because he believed he couldn't read them well enough but he had since bought IBM (and sold some stocks after it languished) and Apple. This proved that Buffett is capable of learning new things and changing his mind and admitting mistakes, learn from them and be a better investor, despite being 86 years old. Now he is saying he regretted never buying Amazon. Maybe he might just buy in 2017?

Anyways, after talking about this point, Charlie added the most wonderful quote in the week, 

"I think that a life properly lived is just learn, learn and learn all the time. And I think Berkshire has gained enormously from these investment decisions by learning through a long, long period. That's continuous learning. If we had not kept learning, you wouldn't even be here. You'd be alive probably, but not here (in Omaha, at this AGM)."

At 86 and 93, these guys are still learning. Here's them telling us, never stop learning, certainly not at our age. The joy of learning is the impetus to wake up every morning, to read more and gain new knowledge. Then eat steak and continue to enjoy life! It reminds me how important it is to be able to enjoy learning, all the way, throughout our lives. Is the Singapore education system inculcating the joy of learning in our kids? That's a big question mark.

Never stop learning!

Anyways, that's Buffett's standing poster at Gorat's. The pins represent people coming from all over the world to eat and learn from him! Unfortunately, he wasn't at the restaurant when we were there and we missed him at the newspaper toss the day before! Hopefully that's a good enough reason to go again, provided the exit permit from OC of the house gets approved. Haha!

So that's the first message. Keep learning all the way! The second message came from the Markel AGM. Markel has been touted as the next Berkshire. It started as an insurance company for buses and trucking industries by the Markel family. It then branched out to other specialty insurance and as it grew, it used its "float" - or excess insurance premium earned by underwriting lots of insurance, to invest. This was pretty much how Berkshire grew in the early days. It had since invested outside of insurance and grew its investment portfolio substantially. Its current CEO, Thomas Gayner, is a remarkable guy and pretty much being compared to Warren Buffett. I attended his 2 hour AGM and learnt so much.

The next takeaway was from him. It was a simple message that came about as he addressed the audience. He speaks fast and most of it quickly lost amongst his words but this phrase was so strong and it just stuck. Again I am para-phrasing him:

"The folks at Berkshire had pretty much said the same things all their lives. That's consistency. I think that's what make them unique. Keep saying the same things because that's really the essence of good communication. There is no ambiguity. It's all about consistency, keep saying the same things, keep the communication simple and most importantly, really do what you say."

In short, be consistent - say what you do and do what you say.

It's easy to just state but how many people can actually do it? And do it for over 50 years? In our current culture of ADHD (attention deficit hyperactivity disorder) demanding instant gratification, we are drawn to our phones every other minute when we get bored. We soon then get tired of the phone itself, and change them every year. In fact, we are changing everything every other year. Most people are changing jobs every three years, changing cars every five years, some are changing houses and even life partners sooner than ever! We are always searching for that something new, but never quite get it right. We want to choose to change but yet cannot accept change if it was pushed onto us. How ironic?

We cannot say what we do and do what we say because we lost the ability to focus, to really grit our teeth and do that hard things to get it right. To sweat it out, push and persevere. It's just too difficult and we are giving up too easily. What I realized is that such a kind of trip is good because it reminds us that it can be done. It is possible to keep saying the same things and to keep doing the same things and live in the same house for 50 years. That's how long term effort can be exhibited with the power of compounding and snowballing.

Warren Buffett's house since 1957

Next post, we will discuss the investing lessons. Stay tuned and wishing all Buddhists a very Happy Vesak Day!

Part 2 is out!

Tuesday, May 02, 2017

More on Sustainability

This is a continuation of the last post.

In the last post, we discussed how we should focus on the big picture and pull the big levers to move things. In diet, it's about cutting meals and cutting meat and putting in the hours in the gym or hit the road running 20 km per week. In investing it's about understanding business models and putting in the hours reading annual reports. Needless to say, investing is also about margin of safety - the biggest lever, the most important concept.

We are really fortunately to be living in the 21st century in the developed world as food is never a problem. We can pretty much eat whatever we want, wherever we want. Our issue is having too many meals. The breakthrough concept should be this: we have 21 meals per week, how many meals should be a treat? Seven? One per day or maybe, for some, every meal? The idea is to know that we will always have enough opportunities to eat whatever we want, wherever we want. Hence, in my opinion, a treat should be once a week or even less. If possible we should eat very little for every dinner because our bodies are winding down for the day and not ready to do heavy duty digestion.

Kay Lee Roast Meat

During the recent long weekend, I had to attend various parties and ate more than my fair share of food as these were "occasions". We just had to eat, because food is love. The next moment, I saw my weight jump and my body spent all its energy digesting Kay Lee Roast Duck (now owned by SGX listed Aztech), BBQ chicken wings, Indian curry and Ba Kut Teh amongst various food. They were all good! But it really took out my sustainable routine of managing my weight. 

Sustainability is truly under-rated. It is way more difficult than most would like to think. My sustainable regime was supposedly light dinner at least 5 times per week, exercise at least 2 times per week. This was thrown out over the long weekend and it took weeks to get back. A famous musician once said, "if I didn't practise for a day, I know it. For two days, my wife knows it and for three days, the whole world knows it." It takes great effort to sustain simple things. But once achieved, then anything is possible. Like waking up 5am every morning for ten years to swim bags an Olympic Gold. 

In investing, sustainability manifest itself in a similar fashion. I would like to illustrate this with companies' return on investing capital or ROIC in short. We all love hyped up stories of high ROICs bcos these justify super high PEs and super high stock prices. But the real question is, are they sustainable? Let's look at the famous tech stocks of recent days past, Linked In, Twitter, Fitbit, Alibaba and Facebook. All of them started with high ROICs in the days of their listing. Alibaba had 200% ROIC but had since collapse to 18% (still not bad). Meanwhile Linked In, Twitter and Fitbit all saw their high ROICs turned negative in a span of a few quarters. Only Facebook had managed to maintain a very high ROIC over 30% (peak was 80% though) although we could say it's history is still short compared to brick-and-mortar firms with truly sustainable high ROICs. 

Unsustainable 35% ROIC vs Sustainable 15% ROIC

Let's delve deeper in this. The chart above shows two hypothetical companies. The one on the left has a high ROIC of 35% to begin with but subsequently falters off to 5% (still positive) by Year 4 while the one of the right simply managed a sustainable 15% ROIC (which is what great co.s like Colgate or Diageo can do) forever. At the end of 15 years, which is the investment horizon that most should think about (not 15 months), we can see how the accumulated returns compare. The one that started with 35% only earned $3,841 with a starting equity of $100 while the other had $5,572 which is c.50% higher.

35% ROIC taken over by the 9th year

In fact, the sustainable ROIC firm would generate more returns after the 9th year. Yes it will still take 9 years but this is how investors should be thinking. We cannot be chasing unsustainably high ROICs every year and hoping to run out in time and catch the next one. It's too tiring. Chances are, we won't run fast enough. How many investors in Fitbit, Linked In and Twitter would have managed to get out in time before these stocks collapse 30-50%?

Unsustainable 50% ROIC vs Sustainable 15% ROIC

Next we look at another example. This time we have a 50% ROIC vs again a 15% sustainable ROIC. This one would look more like our Twitters and Fitbits. But as high as a 50% or 100% ROIC, we should imagine that the collapse would also be fast and furious. In the example, we would model its ROIC to fall to 10% in Year 2 and then 5% in Year 3. To give the hypothetical firm the benefit of the doubt, let's assume that it doesn't turn negative (which is not true in reality given that Linked In, Twitter, Fitbit all turned negative). At the end of 15 years, we see a similar pattern. The sustainable company would have accumulated c.50% more equity vs the once 50% ROIC firm.

50% ROIC 50% taken over by the 7th year

Again if we look at the time frame when the sustainable firm earns more, it's even shorter than the previous example. By the 7th year, the 15% sustainable ROIC firm would have made more returns. Of course, all these are just hypothetical. In reality, these numbers are generated by hundreds and thousands of workers doing their jobs well. As such, it is already a feat to sustain 15% ROIC. Most firms would only be able to manage a mid to high single ROIC. That's because basic economic theory tells us that competition competes away excess returns as soon as possible. Just imagine, if we know some business can make 15% easily, wouldn't we all be in it? Hence 5% ROIC should be the norm. People who argue that 50% or 35% ROIC is sustainable likely don't know what they are talking about. Yes, there might be a handful of maverick firms globally that might do 35% sustainable ROIC, but we cannot assume the one we invested in would be the one.

Likewise, 15% ROIC for 15 years would be feats only achievable by moat companies. Moat companies have unique characteristics that help keep competition at bay, like brand, scale, eco-system, businesses with recurring revenue etc. Hence they are capable of generating and sustaining high returns. These are your P&G, Unilever, Colgate amongst others. In Singapore, sadly, it's even more rare. SIA Engineering managed to do 16% years ago but its ROIC had since dropped to 7% partly as a result of its large cash holdings. Singtel had managed a 12% ROIC for the last five years.

It is the constant and continuous effort that makes the difference. Just as I found out how difficult it was to keep a simple cut dinner and exercise regime, just as the new buyers of Kay Lee roast joint found it hard to sustain and even expand a 70 year old household brand to a regional franchise, the sustainably high ROICs of some of the best global businesses should be revered. Thinking big and sustaining the effort to make it happen, that's the secret to success in investing and perhaps everything else in life.

Wishing all readers a very Happy Labour Day!