The Buy List YTD
Posted by Eddy Elfenbein on March 5th, 2008 at 4:49 pm

The Buy List had a very good day today. We gained 1.05% compared with 0.52% for the S&P 500. Over the last four days, the S&P 500 is off 2.48% while we’re only down 1.02%.

For the year, our Buy List is down 8.81% compared with a loss of 9.17% for the S&P 500.

WaMu protects exec bonuses from subprime fallout
Posted by Eddy Elfenbein on March 5th, 2008 at 12:15 pm

So few corporate boards are willing to stand up for incompetent executives. Thank you, WaMu!

The board’s committee said in light of the challenging business environment and the need to evaluate performance across a wide range of factors it will take a three-step approach to rewarding its executives including subjectively evaluating company performance in credit risk management.
In January, Seattle-based Washington Mutual said it awarded Killinger 3.2 million stock options for 2008 to provide a “strong incentive to restore shareholder value”.
WaMu’s share price sank 70 percent in 2007 as mortgage losses soared.

Danaher Reaffirms Q1 Forecast
Posted by Eddy Elfenbein on March 5th, 2008 at 12:04 pm

Good news from Danaher (DHR). The company reaffirmed its first-quarter earnings estimate of 84 to 89 cents a share. That doesn’t include a five-cent charge related to its acquisition of Tektronix. Wall Street’s consensus is for 88 cents a share.
The stock has pulled back sharply this year, but the shares had a pretty good run over the past few years, so some consolidation isn’t a big surprise. Management has been pretty good about controlling Wall Street’s expectations. For the past few years, Danaher usually meets or just barely beats expectations.
Danaher has been a pretty shrewd dealmaker. Larry Culp, the CEO, said that the company may take advantage of the lower prices that the stock market is offering.

CEO Larry Culp told the Citigroup Global Industrial Manufacturing conference the company’s portfolio transformation toward higher-margin global businesses such as medical instruments is continuing, and deals are set to play a prominent role.
“We’re optimistic about M&A in this environment,” Culp said. “You go back to the last time we saw a slowdown, we were very active in ’02.”
“But I wouldn’t say our pipeline has changed materially,” he added. “Valuations in the public markets have come down … (but) it may be a little early to really see the things in the pipeline come into the zone where they’re actionable.”

The Dow/Nasdaq Ratio Hits a 3-1/2 Year High
Posted by Eddy Elfenbein on March 4th, 2008 at 3:44 pm

The Dow/Nasdaq ratio closed yesterday at 5.428, which just barely passed the peak from August 8, 2006. The ratio is now at its highest level in 3-1/2 years.

I should add that the ratio has been very steady over the past few years. Here’s a chart of the ratio going back to 1980:

Over the last 15 years, that ratio has been between 4.5 and 5.5 for 74% of the time.

The S&P 500 Is Close to a New Low
Posted by Eddy Elfenbein on March 4th, 2008 at 2:45 pm

Another rough day has pushed the S&P 500 below 1310. The lowest close since the October 9 high (1,565.15) came on January 22 when the S&P 500 closed at 1310.5. In other words, the bear market may not be over. Of course, it’s hard to tell when it truly is over.

The Yield Curve Unravels
Posted by Eddy Elfenbein on March 4th, 2008 at 12:46 pm

I ran a chart like this a few weeks ago, but it’s worth revisiting.

The collapse of the yield curve is simply stunning. Not that long ago, all of the lines were fairly stable. Now, they’re plunging (at least, the blue and black) and there seems to be no end in sight.

More on Efficient Markets
Posted by Eddy Elfenbein on March 3rd, 2008 at 2:54 pm

People spend more time on buying a toaster than on buying a house.
Of course, they’re really nice toasters.

The Bubblephobes
Posted by Eddy Elfenbein on March 3rd, 2008 at 2:32 pm

Robert Shiller writes in yesterday’s NYT about the collective failure to see the housing bubble. Obviously, some folks will insist that they saw everything coming, and it was perfectly predictable.
One of the problems I have with this idea, and I’ve mention this before with Shiller’s other work, is the curious idea that a bubble is somehow a problem that needs to be fixed.
Just because prices go up very rapidly doesn’t mean something is a bubble. Oddly, the only time we can be certain that it’s a bubble is when the air deflates and the asset prices go down. In other words, to the bubble-phobes, the problem isn’t the bubble, it’s the downside, and we only know what after the fact.
How can we be sure it’s a bubble when an asset inflates? In the 1950s, stock prices soared and they never really came back down. The phrase “permanently high plateau” hasn’t had a good record since the 1920s, but I think that’s an accurate description of what happened in the 1950s.
Is gold a bubble right now? What about oil? Or the euro? Or could it be that we’re simply adjusting to a new era of commodity prices? I don’t know and for now, I’m happy to consider these open questions. I will note, however, that adjusted for inflation, commodity prices have historically plunged.
For me, the best definition of a bubble is a price that’s going up because it’s going up. The certainly happened with tech stocks in the 1990s. But I’d rather not have Alan Greenspan tell me what the prices of tech stocks ought to be.
There’s also the counter argument that bubbles aren’t merely not bad, but actively good. In his book, Pop!: Why Bubbles Are Great For The Economy, Daniel Gross writes how bubbles and their ugly aftermath have often helped lay the ground work for future prosperity. A bubble creates enormous excess capacity which can later be used to bring down the cost of apply a new technology.
Shiller writes, “The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world.” Actually, the collapsing house of cards is the recognition of the bubble. After all, the bubble could have gone for another three years. Perhaps free enterprise spot it early and cut it off. Hooray for markets!

Oil Hits Inflation-Adjusted High
Posted by Eddy Elfenbein on March 3rd, 2008 at 1:00 pm

The WSJ reports that oil is at an all-time high even after adjusting for inflation.

Crude-oil futures have topped the inflation-adjusted high set in April 1980, as the dollar’s descent continues to send investors into the commodities markets.
Light, sweet crude for April delivery traded as high as $103.95 a barrel on the New York Mercantile Exchange, topping a 1980 trade of $103.76 in 2008 dollars. The April contract recently traded at $103.59. Brent crude on the ICE futures exchange was trading up $1.72 at $101.82.
The 1980 record predates the creation of the crude futures market on Nymex, and represents a deal on the cash market.
Oil began to take off Monday morning after the U.S. dollar fell from a stable position overnight against the euro. Shortly after 9 a.m. EST, the dollar hit a new low, and oil began to rise rapidly. A fresh record for crude in real dollars came minutes later, and deals above the 1980 high were completed at about 9:55 a.m. EST.
“It doesn’t look like it’s going to come down anytime soon,” said Phil Flynn, an analyst at Alaron Trading Corp. in Chicago.

Buffett on the Dream Business
Posted by Eddy Elfenbein on March 3rd, 2008 at 10:50 am

More from the Chairman’s Letter (page 8):

Let’s look at the prototype of a dream business, our own See’s Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See’s, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.
At See’s, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See’s sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.
We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.
Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See’s has given birth to multiple new streams of cash for us. (The biblical command to “be fruitful and multiply” is one we take seriously at Berkshire.)
There aren’t many See’s in Corporate America. Typically, companies that increase their earnings from $5 million to $82 million require, say, $400 million or so of capital investment to finance their growth. That’s because growing businesses have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments.
A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment. There is, to follow through on our example, nothing shabby about earning $82 million pre-tax on $400 million of net tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.

(Hat Tip: Climateer Investing)