Wu Li Masters

He begins from the center and not from the fringe He imparts an understanding of the basic principles of the
art before going on to the meticulous details, and he refuses to break down the t ai chi movements into a
one-two-three drill so as to make the student into a robot The traditional way is to teach by rote, and to give
the impression that long periods of boredom are the most essential part of training In that way a student may go on for yeai s and years without ever getting the feel of what he is doing

Physical concepts (and Markets) are free creations of the human mind, and are not, however it may seem, uniquely determined by the external world In our endeavor to understand reality we are somewhat like a man trying to understand the mechanism of a closed watch He sees the face and the moving hands, even hears its ticking, but he has no way of opening the case If he is ingenious he may form some picture of a mechanism which could be responsible for all the things he observes, but he may never be quite sure his picture is the only one which could explain his observations He will never be able to compare his picture with the real mechanism and he cannot even imagine the possibility of the meaning of such a comparison

In Einstein's words:
. . . creating a new theory is not like destroying an old barn and erecting a skyscraper in its place. It is rather
like climbing a mountain, gaining new and wider views, discovering unexpected connections between our starting point and its rich environment. But the point from which we started out still exists and can be seen, although it appears smaller and forms a tiny part of our broad view gained by the mastery of the obstacles on our adventurous way up.

How cool is that:) all you have everknown is rendered redundant! Einstein + Bohr killed Science's best held idea!
The mathematically formulated laws of quantum theory show clearly that our ordinary intuitive concepts cannot be unambiguously applied to the smallest particles All the words or concepts we use to describe ordinary physical objects, such as position, velocity, color, size, and so on, become indefinite and problematic if we trv to use them of elementary particles

Boxed world
The ability to predict the future based on a knowledge of the present and the laws of motion gave our ancestors a power they had never known However, these concepts carry within them a very dispiriting logic If the laws of nature determine the future of an event, then, given enough information, we could have predicted our present at some time in the past That time in the past also could have been predicted at a time
still earlier In short, if we are to accept the mechanistic determination of Newtonian physics—if the universe really is a great machine—then from the moment that the universe was created and set into motion, everything that was to happen in it already was determined According to this philosophy, we may seem to have a will of our own and the ability to alter the course of events in our lives, but we do not Everything, from the beginning of time, has been predetermined, including our illusion of having a free will The universe is a prerecorded tape playing itself out in the only way that it can The status of men is immeasurably more dismal than it was before the advent of science The Great Machine runs blindly on, and all things in it are but
cogs

Financial memory

"for practical purposes, the financial memory should be assumed to last, at a maximum, no more than
20 years." 2008 => 2028

This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind.It is also the time generally required for a new generation to enter the scene, impressed, as had been its predecessors, with its own innovative
genius.

The guilt lies, as always, with those who sought so eagerly and by such a transparent device to be so separated from their money.

1987 - so now the age of Ronald Reagan. Leverage came back in the form of corporate takeovers and leveraged buyouts, small ownership and control made possible by large debt.

Did Drexel do itself in? Or was it done in? The truth is that this was a case of suicide-and murder. So potent had the firm become that employees truly believed they could do whatever they wanted without fear of retribution. That's why they could threaten Fortune 500 corporations with takeovers and never expect
political retaliation. And that's why they could leverage themselves and their clients to the hilt without preparing for the day debt would go out of fashion. Says a former officer: "You see, we thought, 'We are invulnerable.'"

Stockbrokers fueled the rapid expansion of their business by offering easy credit terms.22 The call loan market, a
relatively new and rapidly growing market, rose rapidly, quite like the securitized debt market grew in 2005-07.
The diversion of funds to invest in the call loan market by corporations, foreigners, and individuals reflected a
speculation in credit, motivated by attractive interest rates, that fueled the speculative mania in stocks of the
period in much the same way the carry trade did in 2006-2007.23

Stocks sold at extremely high multiples financed by borrowing (i.e., margin). Many stocks were valued as much as 30 to 50 times earnings. Then money started to tighten. In May 1928, the Federal Reserve System began tightening credit, raising its discount rate to 4 ½%. It was raised again to 5% in July 1928 and to 6% in August 1929

Irving Kahn

Backtracking to 1977, Kahn contributed another article, titled “Lemmings Always Lose” to the journal, in which he outlined the simple rules of intelligent investing:
1. Don’t depend on recent or current figures to forecast futures prices; remember that many others knew them before you did.
2. Prices are continuously molded by fears, hopes, and unreliable estimates; capital is always at risk unless you buy better than average values.
3. Remember that many complex factors—such as accounting choices and the human problems within management and with large shareholders—lie behind reported earnings.
4. Disregard the competition at your peril—they are always attacking your company’s trade position and its earnings.
5
. Don’t trust quarterly earnings. Verify reports through the source and application statement. Figures can lie and liars can figure. The analyst must both practice, and to his client preach, patience. Fortunately for us analysts, it is unlikely that in this ever-changing world any formula will ever successfully replace the study and objective analysis of individual securities.

You say you feel a recovery? Your feelings don’t count. The economy, the market: They don’t care about your feelings. Leave your feelings out of it. Buy the out-of-favor, the unpopular. Nobody can predict the market. Take that premise to heart and look to invest in dollar bills selling for 50¢. If you’re going to do your own research and investing, think value. Think downside risk. Think total return, with dividends tiding you over. We’re in a period of extraordinarily low rates—be careful with fixed income. Stay away from options. Look for securities to hold for three to five years with downside protection. You hope you’re in a recovery, but you don’t know for certain. The recovery could stall. Protect yourself

Diverse interests!

He had several extraordinary characteristics. His speed of thought was so great that most people were puzzled at how he could resolve a complicated question directly after having heard it. His mental training came from his rigorous study of mathematics, particularly geometry, which required close and exact reasoning before accepting or rejecting either a premise or a conclusion.
He had another extraordinary characteristic in the breadth and depth of his memory. This explains why he could read Greek, Latin, Spanish, and German. Even more remarkable, without having studied Spanish formally, he was able to translate a Spanish novel into literary English so professionally that it was accepted by an American publisher.
In his early years, Ben was both a skier and a tennis player. But his real pleasure was to exercise his mind over a wide range of subjects far beyond his specialties in the world of finance. He loved music, especially the major operas, for the wisdom of their lyrics, as well as their melodies. He had a private, but serious hobby of making improvements in the field of plane geometry. He actually patented several versions of a simplified protractor and a circular slide rule.
In sum, Ben Graham was such a rare combination of qualities [that] only those who knew him well over the years can do full justice to presenting the whole man. In the world of finance Ben’s epitaph will be as was Christopher Wren’s in St. Paul’s, “If you seek his monument—look about you.

-------------------

A voracious reader, Kahn devours everything except fiction, which adds little value to his search for investment ideas. In addition to reading several newspapers a day, he also reads scientific journals and technology magazines regularly. A close follower of the latest news and trends, he has read thousands of nonfiction books—most of which are heavily marked with his apt comments.
When asked how he has generated investment ideas for so many years, he responds that it is really all about absorbing numerous types of information, from economic news to science, from psychology to annual reports, and from financial journals to history, and then combining them to generate a broad perspective on the future.
He further explained, “Reading about science gives me an open mind! When European scientists discovered uranium and found that it could produce power, people thought they had had too much to drink. Many scientific ideas that sounded unbelievable in the early days of my life have now become reality, so it is important to read science books and to learn about the future.”
When hot ideas fall into his value territory during economic recessions and market corrections, Kahn buys. “Real investors should never feel bearish because the time to buy value is when markets go down!”

--------------------

Walter Schloss

Walter Schloss

Because I don’t like stress and prefer to avoid it, I never focus too much on market news and economic data. They always worry investors! Besides, I am not good at market timing, so when people ask me what I think the market is doing, their guess is as good as mine.” Instead, he said, he concentrated primarily on the price of a stock and its value, an exercise he has greater confidence in.

When Schloss started his own fund, he established the rule that he would never disclose its investment holdings: “I did that for several reasons. First, I found that investors like to focus on losing stocks, and I’d become really stressed if they came crying and asking me about what had happened. Second, I found that if people knew what I was buying, then I’d get more competition.”

(Should be incorporated after a certain critical mass)

“My average holding period was about four to five years,” Schloss explained, “and so there was plenty of time for cheap stocks to get back to their true worth. Besides, they would be treated as long-term capital gains for tax purposes.” He fondly recalled Ben Graham once saying that “one should buy stocks the way you buy groceries and not the way you buy perfume,” noting that “I felt that I was a grocery store owner, holding stocks as my inventory. Sometimes these stocks paid dividends, and so they were worth the wait. Eventually, someone would come along and offer a good price for my inventory, and I would sell.”
Unlike many fund managers who like to talk to management and understand a company’s business, Schloss’s sole interest was in looking at the statistical side of a stock. Doing so meant “focusing on the downside and not losing money,” he explained. “When a stock trades below its working capital, the investor begins to get protection.”

Schloss elaborated: “I always like to find companies with no to low debt because debt complicates things. I also like to see whether management owns enough of the company’s stock to serve in its best interests. But you often have to keep track of management’s actions, digging into the footnotes of financial statements to see if they are honest people.

“When I buy a stock, I never visit or talk to management because I think that a company’s financial figures are good enough to tell the story. Besides, management always says something good about the company, which may affect my judgment. I know a lot of good investors who like to talk to management and visit companies, but that’s not me. I don’t like that kind of stress, and if I had had to run around visiting so many companies, I would have been dead after a few years!”

What is ultimately important, Schloss said, is to be comfortable with who you are and to make sure you can sleep at night because managing other people’s money is a heavy responsibility.

Schloss explained: “We changed our strategy a little, but remained true to Graham’s principle of downside protection. We looked for stocks that were selling below their book value. What we tried to do was to buy assets at a discount instead of buying earnings. Earnings can change quickly, but assets don’t, and so the new strategy worked well for a while.”

However, it was not long before even this new book value strategy and Graham’s way of investing simply became inapplicable in the modern world. For Schloss, it was difficult to judge whether the world had become smarter or riskier. Either way, retirement beckoned, and Schloss decided to close down the business in 2001 after more than 45 years of managing money.

He explained: “I had turned 85, and one day my son said to me, ‘Dad, I can’t find cheap stocks anymore!’ So I said, ‘Let’s go out of business!’ We liquidated the partnership and gave back the money to investors.” One thing Schloss learned in his long life was the importance of avoiding stress: “Finding cheap stocks became too stressful, and so it was time to stop looking.”

Baupost 1998

High Valuations
Sector that trades at out of whack multiples
Hot IPOs
Retail Frenzy

Of these four factors, retail frenzy is missing!

Going forward, we will seek to focus on low risk investments while emphasizing capital preservation.
Although emerging markets are bargain priced by historical standards, we will maintain a
much more limited exposure to them in the future, including, as much as possible, an emphasis on
situations with catalysts for the realization of underlying value. Until the developed stock markets
retreat from record levels of valuation, we expect to have less portfolio exposure to equities going
forward and more exposure to event driven situations such as liquidations and reorganizations that
are not so dependent on the vicissitudes of the stock market for their investment return. Also, we will demand more compelling undervaluation than before to incur market risk. In the absence of appropriate
opportunities, we will hold increased levels of cash. Finally, while we still expect to hedge
against extreme conditions, the aforementioned combination of greater undervaluation, catalysts,
potentially higher cash balances, and hopefully better aligned hedges should result in much improved
performance.

It is evident that we are in the midst of a stock market mania, with the usual accoutrements: hot
IPO's, a market sector attracting enormous speculative activity (internet stocks), rising margin debt, (redux in 2014)
and the late 1990's innovation: at home trading via the internet. Most significantly, the prevailing
bullish arguments focus on momentum, money flows, and inevitability; valuation underpinnings are
not mentioned as part of the bull case.

Just as in the early 1970's, but perhaps even more pronounced, there has been a stampede to
own a "nifty-fifty", several dozen widely admired companies seeming to promise an investment utopia
of safety, stability, steady growth, and liquidity.

Finally, we do not believe the current market mania will end without the ending of its twin, the
mutual fund mania. U.S. equity mutual fund assets have surged tenfold since 1990, helping to fuel
the market boom. Overconfident individual investors, projecting the stock market's recent performance
indefinitely into the future, have developed a blind faith in the merits of equity investing, the
fundamentals notwithstanding. They have also developed supreme confidence in their own willingness
to remain invested in the face of unfavorable developments, a confidence reinforced by their
successful buying of the market's dips for the past 16 years (did not understand, is he saying don't buy market dips?). When the tide goes out, as it has in Japan
for the past eight years, money will flow out of the market and out of mutual funds (as it has in Japan);
buying the dips will significantly exacerbate the pain.

------------------------------------

We prefer to invest with a catalyst present to facilitate the partial or complete realization of underlying
value. There is, however, significant competition for these sorts of opportunities from other
investors, rendering many of them unattractive for investment; by contrast, uncatalyzed value situations
today attract few buyers. Seemingly, it would make sense to increase our commitment to the
deeply depressed uncatalyzed investments that are much more undervalued and where there is considerably
less competition. Our concern is that we cannot know when the current love affair with large
capitalization growth stocks will end, and what sort of havoc this will wreak on smaller stocks, however
inexpensive. As we have explained before, the only logical way to hedge against this risk is to protect an
investment in these undervalued smaller stocks with a put option on or short sale of more expensive
stocks. We have ruled out short selling for a number of reasons, including the unlimited downside risk
that short selling poses. With puts, at least, your cost is limited to the up-front premium. Such a hedge,
however, is historically quite expensive and, as we learned last year, far from perfect.
Our resolution to this dilemma is to position the Fund's portfolio in three parts.

A major component
is cash (held in U.S. Treasury bills and/or in a U.S. Government securities money market fund), at
around 42% of the Fund's portfolio at April 30. This asset is available to take advantage of bargains,
but represents important dry powder until some of today's market extremes resolve themselves.
Another segment, about 25% of the Fund's portfolio, involves numerous public and private investments
with catalysts for the partial or complete realization of underlying value. This includes
corporate bankruptcies, restructurings and workouts, liquidations, breakups, asset sales and the like.
These situations are generally purchased at expected annual returns of 15% to 20% or more. The
success of these investments depends primarily on the outcome of each situation rather than on the
level of the stock market. There can, however, be month by month fluctuations in the market prices
of these positions.
At April 30, we held about 32% of the portfolio in deeply undervalued securities with no strong
catalyst for value realization. Values in this portion of the portfolio are particularly compelling, with
prices at discounts of 30% to 50% or more from our estimate of underlying asset values. A number of
these positions are former spinoffs, ignored and abandoned in a market not oriented toward smaller
companies. Most of these situations involve partial catalysts for value realization such as ongoing share
repurchase programs and/or insider buying, but these limited catalysts offer only modest protection
from the short-term volatility of the financial markets. This category represents the lion's share of our
market exposure; this is generally the portion of the portfolio that we attempt to hedge. Frequently,
but unpredictably, investments in this category develop a stronger catalyst and move to the previous
category; indeed, the undervaluation itself often attracts such a catalyst. Less often, an investment from
the previous category loses its catalyst and either moves into this category or is sold.

Buffet's 10 x

10x Pretax Earnings! Case Studies: KO, BNI etc.

So, one of the great things about writing a blog is that I get feedback from some pretty intelligent people.  Most of us don't have a Munger to call, but a blog works well too.  If I say something wrong, I'm sure someone would jump in to point it out.

10% Pretax for Stocks Too?

Anyway, I have mentioned 10x pretax earnings or 10% pretax yield as Buffett's valuation measure numerous times here and more than once I've gotten a response saying that this hurdle is for private deals and not for pricing listed companies.  The argument, of course, is that if you buy a stock at 10% pretax earnings, you won't actually earn 10% pretax (due to the additional tax at the investee corporate level whereas in a wholly owned business, a 10% pretax return is actually a 10% pretax return).

It is true that when Buffett speaks of returns in the stock market, he uses GDP growth and dividend yields; earnings can't grow more than GDP and stock returns will reflect earnings growth over time plus whatever dividends you get.

Translating that into individual stocks, you will get earnings growth plus dividend yield equals expected return on the stock.

The only problem with this is that it doesn't tell you what the business is worth.  Would you pay 50x p/e for it?  20x?  The above calculation only works if valuation stays the same.

Anyway, my usual response to this is that many value investors (including Buffett) likes to analyze businesses based on what a rational businessperson would pay for the business in a private transaction.

So, if Buffett is willing to pay 10x pretax earnings for Wells Fargo in a private transaction to buy the whole thing, that is a valuation benchmark for me.  I know that this is not actually possible.  There are size and regulatory issues that will make this unlikely.  But in terms of valuing businesses, I think it is still a useful benchmark.

Is this how Buffett thinks about it? If he pays 10x pretax earnings for WFC stock, he will not necessarily earn a 10% pretax yield.  I don't know the answer to that question. Maybe that's a good annual meeting question.

But as long as I know that Buffett  would be totally happy to pay 10x pretax for the whole business, that's good enough for me regardless of whether that will actually happen.

Yes, you can argue that these "private business transaction" valuations are only valid when there is some chance of a private deal occurring.  But I only think of that when the private valuations don't make too much economic sense to me; valuations per eyeball or per POP valuations in the past, for example, or 40x EV/EBITDA for some media assets, or per acre land valuations etc.; just because some people are paying high prices doesn't mean anything unless there is a real prospect that what you are looking at will also be taken out at some point at the same high level.

Is 10x Pretax Reasonable? 

But 10x pretax earnings, even for listed companies, is not unreasonable at all.  You can translate that 10x pretax into a 15x after tax p/e ratio, and that wouldn't be far off from the 100 year or so long term average of U.S. listed businesses.   Since Buffett buys quality, above average businesses, paying 10x pretax 

is like paying an average price for an above average business.

So even if my view is wrong, it passes the rationality test; why not pay average prices for above average businesses?  And this is not dependent on market p/e or interest rates because you are using a long term average.  We are not increasing valuations due to decreased interest rates.

Case Studies

So, this discussion piqued my interest again so I decided to go back and look at some more of Buffett's big deals.  I use the term "case study", but it's far from it, really.  I'm only looking at one measure; pretax earnings yield or price to pretax profits.  So I apologize for the exaggerated terminology and to folks who come here looking for a 300 page paper on why Buffett bought something; you'll only see one line.  We all know how great the businesses he owns are, so there really is no need to look at that.

So, I looked at the 2005 purchase of Wells Fargo, Walmart and the recent IBM purchases, but what about some of the other older ones?

Again, since the Warren Buffet Library of Corporate Annual Reports doesn't exist yet, I can only look at some of them.

I got lucky and found a 1988 annual report of Coke, so that's good. Let's start there.

Below, let's take a quick look at Coke (KO), American Express (AXP) and Burlington Northern (BNI) (which a prominent value investing academic said was a crazy/insane deal or some such.  We'll see if it really was a bad price) and some others.

Coca Cola  (KO)

From the 1988 KO annual report:

Pretax earnings:   $1,582 million

Net earnings:        $1,045 million

EPS:   $2.85

Shares outstanding: 365 million

Year-end stock price:  $44.63

From the Berkshire Hathaway annual reports, the cost of KO was:

                     #shares owned           cost ('000)       cost/share (my calculation)

1988 AR       14,172,500                  $592,540       $41.81

1989 AR       23,350,000               $1,023,920       $43.85

So with $1,582 million in pretax profits and 365 million shares outstanding, that's $4.33/share in pretax earnings per share.

So it turns out he paid 9.7x pretax earnings as of 1988 and 10.1x pretax earnings as of the end of 1989.  

That's a pretty stunning discovery, even for me.  I think a lot of value investors were puzzled at what looked like a growth stock purchase by Buffett at the time, but it fits right in with the 10x pretax benchmark perfectly.  He didn't payup because KO was a really high quality business; he paid what he normally pays. 

American Express  (AXP)

So this one doesn't quite fit the mold, but let's take a quick look at it (it doesn't fit only because he didn't pay almost exactly 10x pretax earnings, but far less).

The 1994 annual report is the first time AXP showed up in the BRK letter so let's look at that and what he paid for it:

                        # of shares owned          cost  ('000)          cost/share (my calculation)

1994 AR         27,759,941                     $729,919             $26.29

By the way, I know that this is only an estimated cost per share of the stocks.  There may be some adjustments somewhere that might throw this off, but I don't think it would change things materially.

Thankfully, the SEC database goes back to 1994, so let's pull the relevant AXP figures from 1994:

Pretax earnings:  $1,891 million

EPS: $2.75

Shares outstanding:  496 million

So we don't even have to go very far with this one.  It looks like Buffett paid9.6x net earnings for AXP.

Pretax earnings per share comes to $3.81/share, so he paid a 6.9x pretax earnings.

It looks like he got AXP really cheaply.   It got pretty cheap in 2009 too.

Moving on.

U.S. Bancorp (USB)

It looks like he started buying USB in 2006, but maybe earlier.  It shows up first in 2006 on the annual report.  He bought more in 2007.  This is from the annual reports:

                     #shares owned           cost ($mn)       cost/share (my calculation)

2006 AR       31,033,800                  $969                 $31.22

2007 AR       75,176,026                $2,417                $32.45

And here are the figures for USB in 2006 and 2007:

              Pretax          diluted (mn)                  Pretax

              earnings       shares outstanding        EPS

2006       $6,912         1,804                            $3.83

2007       $6,282         1,758                            $3.57

2013       $7,990         1,849                            $4.32

So in 2006, BRK was paying 8.2x pretax earings, and the total cost through 2007 comes to 9.1x pretax earnings of 2007.

And interestingly, BRK increased shares held in USB from 78 million in 2012 to 96 million at the end of 2013.  The pretax EPS of USB was $4.32 in 2013 and the stock traded in the range of 7.4 - 9.5x that figure throughout the year.

Burlington Northern (BNI)

So this is one of his other major purchases that made everyone scratch their heads.  There are two things to look at here; one purchase when he just bought the shares and then a second time when he bought out the whole company.  Let's take a look.

The first time BNI appeared in the annual report was 2007.  In 2006, he said there were two positions worth $1.6 billion that was not listed, so BNI was probably purchased in 2006 and other times too (could be some before and some after).

Here is what the 2007 BRK annual report showed:

                       # of shares owned          cost  ($mn)          cost/share (my calculation)

2007 AR         60,828,818                     $4,731                  $77.78

And these are the figures for BNI for 2006 and 2007:

                                                   2006               2007

EPS:                                           $5.11              $5.10

Pretax earnings:                         $2.96 bn         $3.0 bn

diluted shares outstanding:           370 mn        359 mn

Pretax EPS:                                $8.11             $8.25

So from this, it looks like Buffett was paying 9.4x - 9.6x pretax earnings per share.  Voila!

And then of course, BRK bought the whole thing in late 2009 (on an announcement basis).  The offer price was $100, so let's see what the BNI figures were for 2009.  Even though the figures haven't come out yet when the announcement was made, most of the year was over, so they would have known pretty much what the earnings were going to be.

Here it is:

BNI 2009

EPS:   $6.08

Pretax earnings:  $3,368 mn

Diluted shares outstanding:  348 million

Pretax EPS:   $9.68

So at $100/share, Buffett paid 10.3x pretax EPS of BNI.

A lot of people thought Buffett overpaid, but it turns out he just paid what he always seems to pay.  I know, I know.  What about capex, maintanence capex / depreciation and all that?   Yes, that was the argument back then.  I don't know.  I'm just looking at this and noticing a pattern.  I don't have all the answers!

BNI Tangent

What's a blog post here without a tangent?  As I was doing this stuff, I just took a quick look at the famous 'projections' of BNI that was included in the merger proxy.  Buffett has said that he ignores these management projections, but these are often done by management / investment bankers in mergers so they can do their cash flow discount model analysis and whatnot.

So here are the various projections for BNI from the proxy dated December 2009:

2010 Recovery Case

		2009E			2010E			2011E			2012E			2013E			2014E			CAGR
		(In millions, except per share and percentage data)
Total revenue		$	14,013		$	14,994		$	16,601		$	17,611		$	18,667		$	19,418		6.7	%
Freight revenue w/o fuel			12,372			12,830			14,063			15,014			15,834			16,558		6.0	%
Operating income			3,204			3,421			4,336			4,921			5,360			5,745		12.4	%
EBITDA			4,737			5,052			6,056			6,746			7,313			7,825		10.6	%
Net income			1,631			1,717			2,224			2,476			2,663			2,831		11.7	%
Earnings per share			4.77			5.04			6.88			8.41			9.71			10.96		18.1	%

2011 Recovery Case

		2009E			2010E			2011E			2012E			2013E			2014E			CAGR
		(In millions, except per share and percentage data)
Total revenue		$	14,013		$	14,254		$	15,436		$	16,629		$	17,839		$	18,877		6.1	%
Freight revenue w/o fuel			12,372			12,424			13,345			14,291			15,244			16,044		5.3	%
Operating income			3,204			3,092			3,638			4,241			4,775			5,209		10.2	%
EBITDA			4,737			4,723			5,357			6,063			6,724			7,283		9.0	%
Net income			1,631			1,515			1,842			2,149			2,386			2,572		9.5	%
Earnings per share			4.77			4.41			5.43			6.74			8.10			9.35		14.4	%

No Recovery Case

		2009E			2010E			2011E			2012E			2013E			2014E			CAGR
		(In millions, except per share and percentage data)
Total revenue		$	14,013		$	14,012		$	14,410		$	14,622		$	14,844		$	15,069		1.5	%
Freight revenue w/o fuel			12,372			12,377			12,736			12,953			13,176			13,401		1.6	%
Operating income			3,204			3,010			3,224			3,324			3,314			3,310		0.7	%
EBITDA			4,737			4,639			4,939			5,138			5,249			5,363		2.5	%
Net income			1,631			1,465			1,607			1,660			1,631			1,610		(0.3	%)
Earnings per share			4.77			4.27			4.65			4.87			4.94			5.07		1.2	%

Deeper Recession Case

		2009E			2010E			2011E			2012E			2013E			2014E			CAGR
		(In millions, except per share and percentage data)
Total revenue		$	14,013		$	13,544		$	13,618		$	14,000		$	14,283		$	14,756		1.0	%
Freight revenue w/o fuel			12,372			12,107			12,147			12,351			12,632			12,929		0.9	%
Operating income			3,204			2,759			2,728			2,778			2,841			2,898		(2.0	%)
EBITDA			4,737			4,387			4,440			4,588			4,770			4,943		0.9	%
Net income			1,631			1,310			1,295			1,326			1,369			1,399		(3.0	%)
Earnings per share			4.77			3.82			3.74			3.80			3.89			4.05		(3.2	%)

And check this out.  These are the figures for 2013 that BNI actually booked (from the BNI 10-K):

BNI 2013 Results

Revenues:             $22,014 million

Operating income:  $6,667 million

Pretax income:        $5,928 million

Net income:             $3,793 million

The most bullish projection in 2009 was for operating income of $5,360 million and net income of $2,663 million.  Operating income came in 24% higher and net came in 42% higher!

Lubrizol

OK, so here's one more acquisition.  This name might not give BRK holders a warm and fuzzy feeling (due to the Sokol incident), but it is a major acquisition so it is a relevant data point.

BRK bought Lubrizol in 2011 for $135/share.

For the 2010 year, here are some figures for Lubrizol:

EPS:  $10.64

Pretax earnings:  $1.00 billion

Diluted shares outstanding:  68.8 million

Pretax EPS:  $14.53

So a $135/share purchase is 9.3x pretax EPS.

Recap

So let's just recap all of this stuff I said in the last post (part 5) and this one.

These are the multiples to pretax earnings Buffett paid in these big deals:

KO in 1988/89:    10.1x

AXP in 1994:         6.9x

WMT in 2005:      11.4x

WFC in 2005:         9x

USB in 2006/2007:  9.1x

USB in 2013:  7.4 - 9.5x (range of stock price in 2013)

BNI stock purchase: 9.5x

BNI acquisition:  10.3x

Lubrizol:   9.3x

IBM:  9.7x

I exclude Heinz here as it is a different situation and I think he said he wouldn't have done the deal without 3G.  I may be missing some here as I didn't intend this to be comprehensive by any means, but just looked quickly at some of the large purchases he has made over the years and it is very interesting.

Conclusion

It's amazing how so many of the deals cluster around the 10x pretax earnings ratio despite these businesses being in different industries with different capital expenditure needs and things like that.

Even the BNI acquisition, which many thought was overpriced (crazy / insane deal! Buffett has lost his marbles!) looks normal by this measure; a price that Buffett has always been paying.

And yes, right now I'm the guy swinging around a hammer (seeing only nails), but I notice a pattern and think it's really interesting.

Of course, this actually makes no sense as every company has different capital needs (free cash flow / owner earnings etc.)  Of course, what Buffett calls "owner earnings" are more important than pretax profits.  This was one of the arguments about the BNI deal.

And it is silly to think you can price anything and everything at 10x pretax profits.  Buffett obviously looks at everything else and has a deep understanding of the various businesses and is only willing to pay this amount for the very best businesses out there.

Why he says he will pay 9-10x pretax earnings (OK, for private deals) and yet seems to go out and pay 9-10x pretax earnings on stocks is a good and valid question.

It's amazing, though, isn't it?  Even if it is an odd coincidence.

NEBRASKA FURNITURE (MY TWO CENTS:))

Paid 11-12x after tax earnings. Bought 80% of company at $60 million = 
100%value. This was a little more than BV. Sales roughly $100 mm about 
$7 mm pre-tax earnings; $4.5 mm after tax. German co was trying to buy at 
same time. 

But I don't think 10x pretax earnings for a stock is a bad price if it's a high quality business that can grow over time etc...  (But you still have to answer the question how much growth there will be and how much a shareholder can expect to get back.)