Warren Buffett and The Washington Post

From Warren Buffett’s 1991 Lecture at Notre Dame:

In ‘74 you could have bought the Washington Post when the whole company was valued at $80 million. Now at that time the company was debt free, it owned the Washington Post newspaper, it owned Newsweek, it owned the CBS stations in Washington D.C. and Jacksonville, Florida, the ABC station in Miami, the CBS station in Hartford/New Haven, a half interest in 800,000 acres of timberland in Canada, plus a 200,000-ton-a-year mill up there, a third of the International Herald Tribune, and probably some other things I forgot. If you asked any one of thousands of investment analysts or media specialists about how much those properties were worth, they would have said, if they added them up, they would have come up with $400, $500, $600 million…That is not a complicated story. We bought in 1974, from not more than 10 sellers, what was then 9% of the Washington Post Company, based on that valuation. And they were people like Scudder Stevens, and bank trust departments. And if you asked any of the people selling us the stock what the business was worth, they would have come up with an answer of $400 million…It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what?…If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that.

Talk to Geoff About Warren Buffett and the Washington Post…

Warren Buffett and Walt Disney

We bought 5% of the Walt Disney Company in 1966. It cost us $4 million dollars. $80 million bucks was the valuation of the whole thing. 300 and some acres in Anaheim. The Pirate’s ride had just been put in. It cost $17 million bucks. The whole company was selling for $80 million. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in….in 1966 they had 220 pictures of one sort or another. They wrote them all down to zero – there were no residual values placed on the value of any Disney picture up through the ‘60s. So (you got all of this) for $80 million bucks, and you got Walt Disney to work for you. It was incredible. You didn’t have to be a genius to know that the Walt Disney company was worth more than $80 million. $17 million for the Pirate’s Ride. It’s unbelievable. But there it was. And the reason was, in 1966 people said, ‘Well, Mary Poppins is terrific this year, but they’re not going to have another Mary Poppins next year, so the earnings will be down.’ I don’t care if the earnings are down like that. You know you’ve still got Mary Poppins to throw out in seven more years…I mean there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time…I went out to see Walt Disney (he’d never heard of me; I was 35 years old). We sat down and he told me the whole plan for the company – he couldn’t have been a nicer guy. It was a joke. If he’d privately gone to some huge venture capitalist, or some major American corporation, if he’d been a private company, and said ‘I want you to buy into this’…they would have bought in based on a valuation of $300 or $400 million dollars. The very fact that it was just sitting there in the market every day convinced (people that $80 million was an appropriate valuation). Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street.…

How Warren Buffett Thinks About Micro Cap Stocks

The key to understanding why a stock picker like Warren Buffett made his best returns when he was investing in micro caps is understanding that a neglected stock is more likely to offer a mispriced bet.

The idea that there’s a trade-off between risk and return only makes sense if people are paying attention to a stock and correctly pricing it. In other words, the more people are correctly handicapping the situation, the more there is a trade-off between risk and return. The less people are correctly handicapping the situation, the less there is a trade-off between risk and return. This trade-off is not inherent to the situation itself. A fast horse and a slow horse – a good company and a bad company – only become equal in risk adjusted terms when the necessary and correct bets are placed to move the odds to the point that equalizes the expected payoff.

The trade-off between risk and return comes from price. And the price comes from the betting public placing their bets correctly so that favorites pay less and long shots pay more. If the public bets wrong, there is no trade-off between risk and return.

As Ben Graham said:

“…the influence of what we call analytical factors over the market price is both partial and indirect – partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions.”

In other words, objectively observed prices are the outputs of subjective analysis. Obviously, both the inputs and the black box – the human minds – into which the data is being input will together determine the market price.

People set prices using their minds.

And here’s the thing about minds. They work from experience. And they only experience what they pay attention to.

Here’s William James:

“…one sees how false a notion of experience that is which would make it tantamount to the mere presence to the senses of an outward order. Millions of items of the outward order are present to my senses which never properly enter into my experience. Why? Because they have nointerestfor me.My experience is what I agree to attend to. Only those items which Inoticeshape my mind – without selective interest, experience is an utter chaos.”

So prices depend on attention.

The mere presence of data means nothing. People have to read 10-Ks. And they have to care about them. If nobody pays attention to a 10-K, that 10-K doesn’t enter into a stock price. Because the data in a 10-K only moves stock prices through people’s minds.

If you want to think about it like advertising you can. Some stocks are advertised by analysts and newspaper reporters and their own well-known consumer brands and products. Other stocks are unknown because they’re headquartered in the wrong state or wrong country, because they make stuff you’ve never heard of, and because you …

How to Value a Business

A reader sent me this email:

Hi Geoff,

I have an investment idea at the moment, but am very new to actually valuing businesses so it may take some time to learn how to do it properly.

Thanks,
Ryan

The basic approach to valuing a business is very simple.

Try to start without looking at the stock price. Instead value the entire business. You want to start by using some written in stone valuation ratios without letting concerns about quality, future prospects, etc. cloud your initial judgment. That comes later.

When appraising a business, you want to use the real estate appraisal principle known as “highest and best use“.

You can easily rank a non-financial company’s possible uses from lowest to highest:

1. Liquidation Value
2. Net Current Asset Value
3. Tangible Book Value
4. Earning Power Value

In almost all cases, liquidation value is not the highest use for a business, because even very bad businesses are usually worth more than they can be immediately liquidated for. So normally you skip a liquidation analysis completely and go straight to analyzing the net current asset value, tangible book value, and earning power value.

A business is almost always worth its net current asset value (Net Current Asset Value = Current Assets – Total Liabilities). A business is worth its tangible book value if it earns a return on capital equal to or greater than the future return expected in the stock market. So, if you think the stock market will return 7% a year from now on, any business that earns an 11% pre-tax return on invested tangible capital should be worth its tangible book value or higher since 11% pre-tax is greater than 7% after-tax (assuming a 35% tax rate). Businesses that can’t earn 10%+ on capital may actually not be worth tangible book value. It depends.

The highest and best use for many stocks is #4: Earning Power. Two good rules of thumb here are that a business is normally worth about 10 times EBIT (Earnings Before Interest and Taxes) and 15 times free cash flow. These are just round numbers. It’s not an exact science. I use 10-year average real EBIT and free cash flow. Don’t worry about adjusting for inflation right now. But always make sure you use long-term averages for EBIT and free cash flow (unless we’re talking about super fast growers – which I’m a total dunce at valuing anyway).

I like to use enterprise value instead of market cap to value a stock both in terms of EBIT and free cash flow.

Also, unlike a lot of folks, I always split cash and debt off from the operating business. Cash and debt are just the financial scaffolding around the business. They’re not inherent to the business itself. And they’re not permanent. Just a choice made by the current owner. So, I value cash at 100% and separate it from the invested tangible book value.

That means I appraise …

Where to Find Micro Cap Stocks

In yesterday’s GuruFocus article “Warren Buffett: How to Make 50% a Year in Micro Cap Stocks”, I mentioned this Ben Graham quote:

The chief practical difference between the defensive and the enterprising investor is that the former limits himself to large and leading companies whereas the latter will buy any stock if his judgment and his technique tell him it is sufficiently attractive…The field of secondary stocks cannot be delimited precisely. It includes perhaps two thousand listed issues and many thousands more of unlisted ones which are not generally recognized as belonging in the category of “large and prosperous market leaders”…The intelligent investor can operate successfully in secondary common stocks provided he buys them only on a bargain basis.

So how do you find these secondary common stocks?

Here are 6 places to start:

1. Greenbackd – Toby Carlisle writes this great blog about Ben Graham bargains or “undervalued asset situations with a catalyst” as he calls them. I interviewed Toby last year.

2. Cheap Stocks – Jon Heller writes this equally great blog about Ben Graham net current asset bargains. Actually, as Toby mentions, Jon was part of what inspired him to write his own value investing blog. I also interviewed Jon last year.

3. Interactive Investor Blog – Richard Beddard writes this U.K. centric Ben Graham style value investing blog. He runs a model portfolio called The Thrifty 30. “It’s thrifty because the shares are all cheap, usually in comparison to their average profits over the last ten or-so years.” The Thrifty 30 is a double whammy of off the beaten path stocks for American investors since Richard focuses on secondary stocks and he focuses on the United Kingdom. Most American investors aren’t even familiar with leading U.K. companies. They’re totally clueless about the ones Richard covers.

4. Value Uncovered – This value investing blog covers “mostly small-cap, obscure stocks trading at a large discount to intrinsic value” as well as “merger arbitrage, going private transactions, self-tender offers, (and) bankruptcy plays”. Things you won’t see covered by financial journalists or stock analysts.

5. Shadow Stock – This is a micro cap value investing blog. It gives you a steady steam of quick posts about almost totally unknown value stocks. No matter how much you think you know about micro caps, you’re bound to find a couple stocks here you’ve never heard of.

6. Whopper Investments – This is another value investing blog that often features micro caps. Last year I was searching for any mentions of some micro caps I owned and twice found this blog was one of the only places that mentioned the stock. Whopper Investments often covers stocks you won’t hear about elsewhere.

The other reason a stock can be neglected is because of a special situation. A good example is Ascent Media (ASCMA) – a John Malone investment – selling one business and buying another, all while remaining the same publicly traded stock. That can cause investors …

How I Got Started In Value Investing

I started investing in stocks when I was 14. I didn’t have any real strategy or philosophy. I just tried to buy simple businesses for below average prices. I bought shares of grocery stores, snack food companies, etc. Examples of stocks I bought back then include Village Supermarket (VLGEA), J&J Snack Foods (JJSF), and Activision (ATVI). This was around the time the dot com bubble reached it’s height (like 1998-2000). Many of the stocks I bought were in my home state of New Jersey. I tried to stick to things I was familiar with. I was completely buy and hold back then.

My Dad read an article about Ben Graham. At this point, I was picking all the stocks for my Dad’s portfolio and he thought Ben Graham’s approach sounded like mine. I always started with the balance sheet. Mostly because as a teenager, I had no accounting experience, so the income statement was harder for me to understand. I was pretty much a balance sheet and cash flow statement guy. Mostly, I still am.

Anyway, when my Dad told me about Ben Graham I went out and bought Security Analysis and The Intelligent Investor. I read them and was hooked. After that, I tried to learn everything I could about Warren Buffett’s partnership days and Graham-Newman’s actual operations. I collect Moody’s Manuals from the 1910s to 1940s so I can look at the stocks Ben Graham mentions in his memoirs and Graham-Newman lists in their annual reports. Things like that.

I realized that Buffett and Graham both did best when buying really tiny, illiquid, unknown stocks. Graham did better than 20% a year just in net current asset stocks. And Buffett really does seem to have done 50% in his personal portfolio in the early 1950s. Their better known investments were good – but with the exception of GEICO – never really on the level of those kind of returns they were getting in tiny, unknown stocks.

So that’s become my focus over the years. I turn over my portfolio much more now. I’m willing to sell anything when I find something clearly cheaper. I’m not buy and hold. But I try to own very, very few stocks. Basically, I try to copy Warren Buffett’s approach to his own personal portfolio.

Unfortunately, what I invest in and what I write about doesn’t always match. Most readers are interested in bigger stocks. So I write about them most of the time.

My true love is really tiny, off the map stuff. Bancinsurance is probably the best example of what I invest in. I only managed to buy about 0.5% of the company. So, it wasn’t a huge financial success. But it’s the clearest example of what I look for these days.

Talk to Geoff About How He Got Started In Value Investing…

International Value Investing: PaperlinX (PPX:AU) – Australia

A reader responded to my post asking for stock ideas from other countries, with this email:

Hi Geoff,

Below is a quick and simple analysis of one of the stocks in my portfolio which your readers might be interested in.

Regards,

Danny

PaperlinX (PPX:AU) – Reports

Below is Danny’s write-up on PaperlinX…

***

PaperlinX is the world’s largest paper merchant. It sources and distributes fine paper ranges, specialty paper, sign and display and graphics solutions and industrial packaging materials worldwide. PaperlinX is based in Melbourne, Australia and listed on the Australian Stock Exchange with a market capitalization of A$253m. The current share price is A$0.42 which is close to its all-time low and compares with a peak share price of approximately A$5.85 in 2003. PaperlinX is a deep value idea trading at 0.9x net tangible assets with a 49% margin of safety to my intrinsic value of $0.82.

The paper industry is highly competitive and PaperlinX has undergone significant transformation over the years, closing and selling its manufacturing facilities.  Volumes in the paper industry have been impacted by the weakening global economy and the structural decline in paper use with increased use of electronic communication. Industry participants have responded to the industry downturn by cutting capacity which has mitigated the fall in prices. As you can see below, PPX price/tonne increase in 2009 although dropping again in 2010. I have ignored the impact of the rising A$ which has a negative impact on PPX earnings.

PaperlinX’s very low margins are evidence of the highly competitive industry and its business model has significant operating leverage (a 25% decline in volume from 2006-10 led to a 70% decline in EBIT/sales margin). Increased volumes from current depressed levels will generate significant earnings growth. I have only shown the operating earnings from the Merchant business above which excludes the discontinued manufacturing business, various asset sales and restructuring costs.

An estimate of normalized earnings would be to take an average of the trading EBIT for the last four years which is A$126.1m. This is of course very simplistic and ignores price forecasts, foreign exchange, the benefit of the cost reduction programs etc which have both negative and positive impacts of earnings. If we assume that corporate costs are A$30m (in line with historical numbers), interest expense is A$20m (estimate from company) and corporate tax is 35%, applying a 10x PE multiple, the implied valuation is A$0.82 which represents a 49% margin of safety to the last share price of A$0.41.

The main catalyst for PaperlinX is an improvement in the economy. The Company’s most recent results announcement shows that leading indicators are improving however remain volatile.

I believe that at the current price level, downside risk is limited.  The EBIT implied by the current share price, applying the assumptions above and a 10x PE is approximately A$89m which is half FY2008 EBIT. In addition, at the current share price, PPX is trading at 0.9x net tangible assets.

The risk is a …

Report: Stanley Furniture (STLY) – $5.25 Price Target

A reader of this blog sent me a report he wrote on Stanley Furniture (STLY). The stock currently trades at $4.50 a share. Mason has a $5.25 price target on the stock. Plus, there’s the possibility of additional payments from the Continued Dumping and Subsidy Offset Act (CDSOA).

Mason originally wrote the report before the rights offering. I apologize for not posting it sooner.

Mason would love to get feedback on his report from readers of the blog. So, please send him your thoughts.

Mason Wartman’s Report on Stanley Furniture (STLY)

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International Value Investing: Compagnie Industrielle et Financiere d’Entreprises – France

In response to my post asking for stock ideas from other countries, Pierre sent in an idea about a French stock. The stock is called “Compagnie Industrielle et Financiere d’Entreprises” or CIFE for short.

Compagnie Industrielle et Financiere d’Entreprises (INFE:FP) – Reports

Hello,

I’m a small individual investor in France. Here is an example of an interesting stock listed on NYSE Euronext/Paris. The company is involved mainly in construction (bridges, public works, etc.). Financial Statements are published only in French, on the French equivalent of the Edgar system. The company website and annual reports are in French.

However condensed financial statements can be found in English on MSN Money with the quote FR:INFE.

With a last quote of 59.49 euros, market cap is 70 (million) euros. If you have a look at the balance sheet cash and short term investments 48 Me there is also long term investments 37 Me (those are actually excess cash that was invested in certificates of deposit) long term debt is around 2 Me short term debt is around 11 Me. So basically the company is valued for its net cash. As you can see in the MSN link the company is profitable (has been for 11 years, my records don’t go before that, distributes a dividend, buys back some shares but not each year) 2009 PE ratio is 7. FCF is less good (mean value is ~ 8 Me for the last 6 years, but fluctuates and negative in 2005).

Only 30 % of the stock is public, the rest is owned by the current CEO and his family.

The stock has been moving sideways for a long, long time (MSN, Bloomberg).

Given the sorry state of the French government finances, obviously some major public infrastructure projects will be cancelled.

So here are my questions. I wonder what’s your view on this.

Is it a fantastic opportunity or a trap and why?

Regards,
Pierre

Read my Response

Talk to Geoff About International Value Investing…

International Value Investing: Crown Van Gelder (CVG:NA) – Netherlands

A Dutch individual investor who read my post asking for stock ideas from other countries, posted a write-up on Crown Van Gelder over at GuruFocus.

Crown Van Gelder (CVG:NA) – Reports

Investment thesis 
The equity of CVG is available at a discount to its value in liquidation.

The opportunity exists because 

• Earnings are depressed due to rising pulp prices. 
• The company is managed with many interests in mind; just one of which is the interest of shareholders. 
• This is perceived to be a commodity business with no opportunity for differentiation. 

Valuation of Assets and liabilities (numbers in EUR) 

• Current assets (mostly inventory at cost and receivables) => 50m
• PP&E (two paper mills, a modern gas fired power plant and a harbour) => 65m 
• Total liabilities => 30m 
• A 50% stake in IFO BV. A logistics company that pays a 1m dividend. 

Market cap is 30m so the facility, with a book value of 65m, is available for say….15m net. This is one of the cheapest publicly traded companies in the Netherlands…

…CVG managed about 5% net margin over the past decade (excluding 2009 and 2010). The huge losses in recent years were mainly write downs of the assets; CVG is not bleeding cash….3% net margin over a full cycle => 5m.

The author also gave me the name of another interesting Dutch stock: DOCdata.

DOCdata (DOCD:NA) – Reports

By the way, I realized in my response to Pierre’s question about finding foreign microcaps, I kind of skirted the issue of finding small stocks in countries where you don’t speak the language. Instead, I just gave a list of interesting stocks from the U.K.

To prove even Americans can find small stocks in France, here are two French micro caps worth looking at: Poujoulat and Precia.

Poujoulat (ALPJT: FP) – Reports

Precia (PREC:FP)

Talk to Geoff About International Value Investing…