Bear Markets

Our family owned "Larimore's Diner" in Foxboro, Mass. in 1929. I was 5 years old. When the depression hit, we lost the Diner and moved into my grandfather's home in Miami. My grandfather was an investment professional on Wall Street, who like so many others, went bankrupt. We were forced to move when he lost his Miami home (next door to where I live now.)

These figures show what the worst bear market was like:

BEAR MARKET OF 1929-1937 (Dow plunged 89%)

-1929--1930--1931--1932

(-31%)(-25%)(-43%)(-08%) Large Cap Stocks
(-34%)(-35%)(-47%)(-06%) Mid/Small Cap Stocks
(-47%)(-38%)(-50%)(-05%) Micro Cap Stocks

Figures cannot convey the horrifying and debilitating effects of a bear market. You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money. 

Your friends and relatives urge you to sell before losing everything. Nearly all financial 'experts', including newspapers, magazines, and radio commentators recommend "sell". You are ridiculed for trying to hold on. You begin to have self-doubt. Dispair sets in. Buying stocks is unthinkable. Suicide's increase. 

Most stock investors in the 30's sold and never returned to the stock market. Many ended their days with their family in poverty. I remember the "poor farms" on the edge of towns. There were no social security retirement benefits. Beggers were everywhere.

Tesla!

"Mr. Westinghouse," said Tesla, drawing himself up to his full height of six feet two inches and beaming down on the Pittsburgh magnate who was himself a big man, "you have been my friend, you believed in me when others had no faith; you were brave enough to go ahead and pay me a million dollars when others lacked courage; you supported me when even your own engineers lacked vision to see the big things ahead that you and I saw; you have stood by me as a friend. The benefits that will come to civilization from my polyphase system mean more to me than the money involved. Mr. Westinghouse, you will save your company so that you can develop my inventions. Here is your contract and here is my contract--I will tear both of them to pieces and you will no longer have any troubles from my royalties.Is that suficient?"

Buffett Speech - Omaha

How do you develop conviction for contrarian ideas? How do you perceive risk?
At Berkshire we have certain filters that have been developed. If in the course of a presentation or evaluation part of a proposal or of an idea hits a filter then there is no way I will invest. Charlie has similar filters. We don’t worry about a lot of things as we only have to be right about a certain number of things – things that are within our circle of competence.

Have you ever made money on someone else’s ideas? My preference is for my own ideas. I prefer to find good companies trading at fair prices. You can make money on cigarette butt investing but this works better with small amounts of money and was more effective years ago. You can’t build businesses out of cigar butts. I don’t read analyst reports and, although I get served up many ideas I don’t seek outside ideas. I stay within my circle of competence. Berkshire’s AUM means the universe of potential investments is smaller even though good, attractively priced ideas are often poorly covered. For instance, recently I did screening of the Korean market and found a few interesting opportunities. I used a 1950s (1951) Moody’s manual by sector. There was some good stuff in the back on page 1433. Western Insurance was a company that I looked at. It had an EPS of $29 and the high price was $13. Nobody showed me this. So I checked it out with insurance brokers and it checked out OK so I bought into the company. All in all, I prefer to read “raw” financial reports and talk to industry representatives.

With the rise of social media and constant information it seems students are losing the ability to sit down, think, and formulate their own thoughts like you have in the past. We prefer short bits of information to novels. Can you talk about whether you view this as a problem and the impact that deep and independent thought has had on your career? Answer #8: A good part of our success is that we spend a lot of time thinking. At Berkshire, we don’t have any meetings or committees, and I can think of no better way to become more intelligent than sit down and read. In fact, that’s what Charlie and I mostly do.

What are questions investors should ask but usually don’t when evaluating companies Answer #9: Start by looking at 7-8 companies in the industry and ask the management typical due diligence questions. Also, ask the management of each company which competitor they would be willing to put their net worth in for the next 10 years. Then ask which of their competitors they would short. This will provide important insights into the industry that even those who work their whole life in the industry would not realize.

Question #17: What are the things that you need to be able to value a business? Answer #17: In order to best understand a company, you first have to understand the industry. Only focus on companies and industries you understand. Don’t go outside your circle of competence. You need to know what the strengths of the company are in relation to the competition, if they have a good management team, and most importantly, what the moat is. If you don’t know how many competitors the company has, do not invest in the company. Coke’s moat is that it has no taste accumulation, and the moat of railroad companies are that no one can build anymore because of saturation. That is why I am currently invested in both industries

Charlie and I love to read biographies, and what we like to ask is “what makes these people succeed and what makes the ones that fail?” I use Sears as an example to show the ABCs of failure – Arrogance, Bureaucracy and Complacency. And Sears had them all. When you build an organization that has been incredibly successful, you have to work extremely hard to fight off arrogance, bureaucracy and complacency. One thing that Sam Walton and Mrs. B had in common is they had passion for the business. It isn’t about the money, at all. It was about winning. Passion counts enormously; you have to really be doing it because you love the results, rather than the money. When we buy businesses, we are looking for people that will not lose an ounce of passion for the business even after their business is sold. And getting in bed with people like that is what it’s all about.

What are some common traits of good investors? Answer#13: A firmly held philosophy and not subject to emotional flow. Good investors are data driven and enjoy the game. These are people doing what they love doing. It really is a game, a game they love. They are driven more by being right than making money, the money is a consequence of being right. Toughness is important. There is a lot of temptation to cave in or follow others but it is important to stick to your own convictions. I have seen so many smart people do dumb things because of what everyone else is doing. Finally good investors are forward looking and don’t dwell on either past successes or failures but rather

Face Essays

Of course, the more power and prestige the others have, the more a person is likely to show consideration for their feelings, as H. E. Dale suggests in The Higher Civil Service of Great Britain (Oxford, Oxford Univ. Press, 1941 ) , p. 126n. "The doctrine of 'feelings' was expounded to me many years ago by a very eminent civil servant with a pretty taste in cynicism. He explained that the importance of feelings varies in close correspondence with the importance of the person who feels. If the public interest requires that a junior clerk should be removed from his post, no regard need be paid to his feelings; if it is a case of an Assistant Secretary, they must be carefully considered, within reason; if it is a Permanent Secretary, his feelings are a principal element in the situation, and only imperative public interest can override their requirements."

Appearances are deceptive but they matter!

100 to 1 in Stock Market

Was authored during the Nifty Fifty bubble of 1972; Book is on buy and hold strategy of long term winners 

 

Source: capitalideasonline.com

 

Key takeaways:

 

84. "In general there seem to be four categories of stocks that have turned in the 100-to-one performance records. I was about to say there are rather than there seem to be. What stopped me was recalling the story of the show-off who said to the great etymologist: "Have you ever noticed that sugar is the only word in the English language in which ‘su’ is pronounced ‘sh’? The etymologist’s reply was: "Are you sure".
The four categories I see are these:
1. Advance primarily due to recovery from extremely depressed prices at bottom of greatest bear market in American history. Special panic or distress situations at other times belong in this group too.
2. Advance primarily due to change in supply-demand ratio for a basic commodity, reflected in a sharply higher commodity price.
3. Advance primarily due to great leverage in capital structure in long periods of expanding business and inflation."
4. Advance primarily due to the arithmetical result of reinvesting earnings at substantially higher than average rates of return on invested capital."
85. "My fourth category of stocks showing one hundredfold appreciation is that of companies reporting a far above-average rate of return on invested capital for many consecutive years. In such issues the investor has simple arithmetic and Father Times on his side. Even in this category, however, there is no free lunch, no "sure thing". First there is the danger that the high rate of return on invested capital may attract too many competitors. No business is so good that it cannot be spoiled if too many get into it. It is vitally important that the high rate of return be protected by a "gate" making entry into the business difficult of not impossible. Such gates may be patents, incessant innovation based on superior research and invention, ownership of uniquely advantageous sources of raw material, exceptionally well-established brand names – you can fill in others as you choose. Just be sure the "gate" is strong and high. Most of us want pretty much the same material things in life – good food, good clothes, a home on the right side of the railroad tracks, good schools for our children. To get more than the average we must be able to do more than the average, or do what we do better than the average. If all we can do is take in washing there will always be someone down the street ready to take it for two cents a pound less than our price.
Thousands of investors have owned one or another of these 100-to-one "high-gate" stocks at sometime or other in the last forty years. Probably not one in a thousand has held his winner until it increased one hundredfold in value.
All of course wish they had done so. Yet it would be just as great a mistake to assume that what has been will continue to be forever and ever. Or to pay now for all the growth that can be foreseen.
To increase one hundredfold in value in forty years a stock’s price must advance at the compounded annual rate of 12.2 percent. The rates of increase required to multiply a stock’s value by 100 in fewer years than forty are these.
35 years -14 percent
30 years -16.6 percent
25 years – 20 percent
20 years – 26 percent
15 years – 36 percent
"Don’t marry a man to reform him," a wise mother counseled her daughter. It is seldom profitable to marry a stock to reform it either. Sometimes, as with husbands, the hoped for reform never comes. Even when it does come, it is often sadly delayed. Hope deferred maketh the heart sick. Your turnaround candidate may double in price, your gain is at the compound annual rate of only 7.2 percent.
Perhaps the greatest advantage of all in buying top quality stocks without visible ceilings on their growth is that when we do so we give ourselves the chance to profit by the unforeseeable and the incalculable."
92. "The secret of success in your quest for 100-to-one stocks is to focus on earning power rather than prices. Can you do it?"
93. "What is the difference between earnings and earning power? Earnings are simply reported profits no matter how obtained. As we have already seem, earnings may rise because of a sudden, non-recurring surge in demand, because of a price advance, because of a change in accounting practices, because of improvement in business generally which permits utilization of what previously was excess productive capacity. None of those reasons reflects earning power any more than the movement of a cork downstream attests its motive power.
Earning power is competitive strength. It is reflected in above averages rates of return on invested capital, above average profit margins of sales, above average rates of sales growth. It shows to best advantage in new or expanding markets.
Failure to distinguish between ephemeral earnings fluctuations and basic changes in earning power accounts for much over trading, many lost opportunities to make 100 for one in the stock market.
Too much research in Wall Street is not even directed at making
In Alice in Wonderland one had to run fast in order to stand still. In the stock market, the evidence suggests, one who buys right must stand still in order to run fast."
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Subsequent 30 year returns of Nifty Fifty stocks, within this non-tech seems to have generated in-line returns (reminscent of consumer stocks in India)

Table 1 Morgan Guaranty P/E Ratios and Annualized Returns

	1972 P/E	Annualized Return
Polaroid	90.7	-14.68
McDonald's	85.7	10.50
MGIC Investment	83.3	-6.84	(1.41)
Walt Disney	81.6	8.97
Baxter Travenol	78.5	10.10
Intl Flavors & Fragrances	75.8	5.66
Avon Products	65.4	6.04
Emery Air Freight	62.1	-1.37	(-0.16)
Johnson & Johnson	61.9	13.35
Digital Equipment	60.0	0.93	(7.14)
Kresge (now Kmart)	54.3	-1.07
Simplicity Pattern	53.1	-1.47	(-1.32)
AMP	51.8	11.17	(11.92)
Black & Decker	50.5	2.45
Schering	50.4	13.19
American Hospital Supply	50.0	12.36	(5.16)
Schlumberger	49.5	10.37
Burroughs	48.8	-1.64
Xerox	48.8	0.89
Eastman Kodak	48.2	1.72
Coca-Cola	47.6	13.15
Texas Instruments	46.3	11.27
Eli Lilly	46.0	13.14
Merck	45.9	14.27
Upjohn	41.1	9.95	(10.98)
Chesebrough Ponds	41.0	10.96	(6.55)
Minnesota Mining (3M)	40.8	9.78
American Express	39.0	10.30
American Home Products	38.9	13.13
Schlitz Brewing	38.7	6.68	(-0.67)
Halliburton	38.3	3.19
IBM	37.4	9.68
Lubrizol	36.9	7.62
J.C. Penny	34.1	4.83
Squibb	33.9	14.21	(10.26)
Procter & Gamble	32.0	11.94
Anheuser-Busch	31.9	13.55
Sears Roebuck	30.8	6.94
Heublein	30.1	14.66	(4.20)
PepsiCo	29.3	15.55
Pfizer	29.0	16.99
Bristol-Myers	27.6	15.35
General Electric	26.1	15.57
Revlon	26.1	12.40	(6.05)
Phillip Morris	25.9	17.68
Gillette	25.9	14.12
Louisiana Land & Exploration	25.6	4.91	(8.54)
Dow Chemical	25.5	10.80
First National City	22.4	13.36	(12.11)
ITT	16.3	9.99
S&P 500	19.2	12.01

Charlie Munger

The thoughts of others
Were light and fleeting,
Of lovers’ meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
So I was ready
When trouble came.

You can say, who wants to go through life anticipating trouble? Well I did. All my life I’ve gone through life anticipating trouble. And here I am, going along in my 84th year and like Epictetus, I’ve had a favored life. It didn’t make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. It didn’t hurt me at all. In fact it helped me.

The last idea I want to give to you…..is that this is not the highest form that a civilization can reach. The highest form a civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another. That’s the way an operating room works at the Mayo Clinic. So never forget, when you’re a lawyer, that you may be rewarded for selling this stuff but you don’t have to buy. What you want in your own life is a seamless web of deserved trust. And so if your proposed marriage contract has 47 pages, my suggestion is you not enter.

Thursday, May 17, 2007

Charlie Munger - USC Law School Commencement - May 13, 2007