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Tuesday, March 31, 2009

SHARE INVESTOR: Emotional Refuse

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Further to my criticism in February of recent detractors of Warren Buffett's moves to "buy up US stocks", Steve Jordan from The Omaha World-Herald adds another dimension to my argument for me when he quotes me back contrasting my contention that Warren knows his business VS Doug Kass who reckons Buffett is dead wrong in his long-term investment approach:

Bloggers are fighting over whether Warren Buffett's recent financial plays have been wrong or wise. Darren Rickard of the Stock Market & Business Blog sought to refute Doug Kass of RealMoney Silver and TheStreet.com, who said Buffett's strategies are "stale" and don't work these days. Kass cited the declining value of several investments Buffett has made since last fall, plus the 38 percent drop in Berkshire Hathaway's own stock price. Rickard said such criticism is shortsighted and that critics "haven't given Buffett's big bets a time to play out." "Warren Buffett has faced similar stock market and economic meltdowns before, bet huge sums while stocks were affected by these meltdowns and always managed to come out smelling of roses," Rickard wrote. , Omaha World-Herald Feb 8, 2009

I missed this in my February diatribe, Doug Kass points out that Buffett's Berkshire has suffered a 38% drop in share price but what stock hasn't in this market?

Share price isn't always a reflection of real value. Like Kass' view of the stockmarket, this is short term thinking and it is wrong. Stock prices will fluctuate for manifold reasons other than concrete results and the Berkshire Hathaway stock price has been murdered far below its recent results, mostly for emotional rather than actual reasons.

The same is true of many listed stocks in New Zealand.

Emotion has departed from reality and taken some stocks down the road less traveled towards dead mans curve.

There are bargains out there, Warren Buffett is buying them and commentators like Doug Kass are doing their best to make him look bad in the short-term.

I am willing to admit that the great Sage of Omaha could be wrong this time but on the balance of probability it would be a foolish man who would bet against him.

Just be patient, Buffett has spent the last 80 years doing just that and his results speak for themselves.

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K-STATE COLLEGIAN: Buffett greets members of finance group in Omaha

Ann Conrad


Published: Tuesday, March 31, 2009

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In the Cloud Room on the 15th floor of an office building in Omaha, Neb., members of the Student Finance Association took part in a two-hour question-and-answer session with Warren Buffett last Saturday.

Buffett is the chief executive officer of Berkshire Hathaway and was named by Forbes Magazine as the richest person in the world in early 2008, but was moved to No. 2 in 2009 after losing $25 billion last year.

During the question and answer session, Laura Liston, president of SFA and senior in finance and accounting, said Buffett answered very specific finance questions as well as general questions about life lessons, imparting his wisdom on the future field-of-finance students.

Greg Foote, bond funds chairman of SFA and senior in agricultural economics, said communication was one of the most important issues Buffett discussed.

“He told all of us we are great students and have learned all this information ... [but you] have to communicate what you think to other individuals,” he said.

Matt Hewitt, vice president of special events for SFA and senior in finance and accounting, described Bufett as funny, witty and down-to-earth and said the funniest comment Buffett made was that “strategic planning is a waste of time.” He said this was because, as Buffett explained, any acquisition or merger should be a wise decision, so it would obviously be strategic.

The SFA group presented Buffett with a personalized K-State football jersey and a football signed by Coach Bill Snyder after the event.

“After lunch, he kept a smile on his face and took a picture with every single person who wanted to take a picture,” Hewitt said.

Foote said in order to allow the group the opportunity to visit, he sent Buffett a written letter last fall and was told there was a two to three year waiting list for visits. Foote then got a hold of Buffett’s secretary’s e-mail address and began flooding her inbox with requests.

His persistence worked, and when a group canceled early this year, SFA was able to attend in its place. The K-State members made up just 27 of the event’s 100-plus attendees, Foote said.

Hewitt said four other schools were also in attendance, including students from Australia, and the SFA students were the only undergraduate group.

Along with the question and answer session, the group visited Nebraska Furniture Mart and Borsheim’s, a jewelry store, and had lunch at a steakhouse, which Buffett paid for, Liston said. Both Nebraska Furniture Mart and Borsheim’s are subsidiaries of Berkshire Hathaway.

Foote said the trip will help the K-State SFA in the future and has also promoted K-State and the College of Business.

Hewitt said group members “hope we made a good impression for the future.”

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THE STREET: Buffett's Berkshire: Buying All of Burlington?

03/30/09 - 01:53 PM EDT

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Jon "DRJ" Najarian, co-founder of OptionMonster.

When evaluating rumors, you have to decide if the chatter meets the three Vs: volume, volatility and valuation. Let's apply it to today's speculation about billionaire investor Warren Buffett.

Berkshire Hathaway(BRK.A Quote - Cramer on BRK.A - Stock Picks), which owns 22% of Burlington Northern(BNI Quote - Cramer on BNI - Stock Picks), is being chatted up as a potential buyer of Burlington Northern along with Chinese railroad operator Guangshen Railway(GSH Quote - Cramer on GSH - Stock Picks).

Guangshen Railway is trading down 71 cents to $16.11 today, which we could attribute to the 3.4% selloff in the broader market as easily as the rumor of its interest in Burlington Northern. Berkshire, led by Buffett, is also down 4.8%.

So let's break down the three Vs to see if Burlington Northern could indeed become part of the recent takeover wave:

Volatility: Implied volatility peaked at 55% in early March and stood at 47% Friday. Today, Burlington Northern April calls spiked up to 65% again, well surpassing the March highs. May implied volatility stood at 63%.

Volume: Normal full-session stock-trading volume over the last three months has been 4 million shares, but in the first two hours alone today 2.3 million changed hands.

Valuation: Current valuation of Burlington Northern is $20 billion, and our models indicate that a takeover would be at least $26 billion, which is a tough raise right now.

So Burlington Northern meets only two of our three V's, but that doesn't mean there will not be more talk as Burlington Northern trades at about $60.50 per share, down on the day but still double some of its biggest competitors.

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WSJ BLOG: Byron Trott to Leave Goldman Sachs. Warren Buffett Signs On.


Many senior bankers have left big Wall Street firms this year. Yet, among the big names rushing hither and yon, here is name that sticks out: Goldman Sachs Group’s Chicago banker Byron Trott–Warren Buffett’s most beloved banker and onetime heir apparent to Hank Paulson–is leaving to start his own firm.

Trott is the latest veteran investment banker to leave such big firms as Goldman Sachs, Morgan Stanley and Bank of America Merrill Lynch, among others. But while most have been scarfed up by rivals or have gone the boutique route, Trott will start a merchant-banking firm that will include a $2 billion fund to invest in family-controlled and entrepreneurial companies and advise them, according to our deals czar, Dennis K. Berman.

It’s hardly a blow to Buffett, who will maintain both his relationships with Trott and with Goldman Sachs. Buffett told WSJ colleague Scott Patterson that “a few months ago, he said, he met with an individual at the bank who will ‘take care of me’ after Mr. Trott departs.”

Buffett, who invested $5 billion into Sachs at Trott’s suggestion, will invest money in Trott’s new venture as well. “We’ll have a modest partnership interest,” Mr. Buffett said in an interview with Patterson, although he noted, “We will not be the big dog.” As to the other investors, “Most of them will be from a group of family companies that in one way or another he’s been close to,” Buffett said.

Trott’s focus on family-owned companies harks back to his early days in investment banking, when he advised high-net-worth individuals in the Midwest as part of Goldman’s wealth-management group. Very often, those investors were CEOs of small companies as well, which brought Trott to the attention of Goldman’s investment bankers in Chicago–including Hank Paulson, who then headed the Chicago office and boosted Trott’s career.

To many on Wall Street, Trott’s departure isn’t a shock. Rumors abounded at least once a year for the past six years that Trott would strike out on his own, each time debunked, only to be resurrected the next year. The rumor that Trott would join–or even succeed–Buffett also was persistent.

The last week has brought even more departures of senior bankers, a trend that started to take shape earlier this year. This week, Merrill Lynch European energy banker Jonathan Grundy joined Credit Suisse, while Morgan Stanley banker Maurice Marchesini — who advises Midwestern banks — joined UBS along with former Banc of America veteran Sean Minnihan, who advises financial technology firms.

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FORBES: Goldman buys $58 mln Winkelried, Palm fund stakes

03.30.09, 12:56 PM EDT

pic

By Joseph A. Giannone

NEW YORK, March 30 (Reuters) - Goldman Sachs Group Inc (nyse: GS - news - people ) last year paid a combined $58 million to Co-President Jon Winkelried and General Counsel Gregory Palm, (nasdaq: PALM - news - people ) buying out two top executives suffering from a severe cash crunch.

Proxy documents filed with the Securities and Exchange Commission Friday also showed that Chief Executive Lloyd Blankfein and other officers, though forgoing 2008 bonuses, received substantial returns from exclusive investment funds.

Goldman disclosed it purchased employee fund interests from Palm for $38.3 million and from Winkelried for $19.7 million to help them 'meet their liquidity needs,' a Goldman spokesman said. Without those deals, two of the bank's largest stockholders may have raised cash through stock sales.

'Neither we nor the executives involved thought it was in the interest of the firm for them to sell shares in an extraordinarily turbulent market,' a spokesman said. 'We thought it would send the wrong signals.'

Winkelried, 49, is the second-largest individual Goldman stockholder at 2.8 million shares, according to the proxy. Palm is the third-largest.

Winkelried cashed out roughly 30 percent of his employee fund holdings, while Palm sold 25 percent. Goldman chose which stakes it wanted and negotiated the price.

The decision to buy the executives out was made in early September, before Goldman accepted $10 billion in government funds, the spokesman said.

Speculation has swirled about the circumstances surrounding Winkelried, 49, since the veteran trading and investment banking executive placed a Nantucket, Massachusetts, estate on the market last fall for $55 million.

Last month, Goldman announced that Winkelried would retire, effective Tuesday. There was market talk that Winkelried, who also owns a house in Short Hills, New Jersey, and a horse ranch in Colorado, had been squeezed by falling investments.

SPECIAL POOLS

These unusual internal dealings shined a spotlight on Goldman's investment pools, which let employees participate in Goldman's merchant banking, venture capital, real estate and other funds.

The proxy said shares in 2008 funds were purchased by Goldman for the same amount executives put in. Shares in private equity and hedge funds were bought at a discount.

Goldman explained that it offers up to $500,000 of financing to each employee across all funds.

The bank said last year it continued to provide loans to officers, spouses and affiliates who invested in vintage 2000 funds that offered a fixed return.

Earlier this year, Goldman offered to buy out fund stakes to provide cash for employees whose money was tied up in long-term investments, such as Goldman's Whitehall real estate fund. Buyouts were made at an undisclosed discount.

STILL WEALTHY

Late last year, Goldman's top executives announced their decision to give up all cash and stock bonuses in response to public outrage over Wall Street compensation amid the mounting cost of the bailout, rising unemployment and slowing economy.

Yet the proxy also showed that Goldman's partners and top executives still received lucrative returns from these employee funds, offered under favorable terms.

Blankfein received $11.3 million of distributions from these funds last year, while Winkelried received nearly $5 million. Palm received $10.9 million while Gary Cohn, soon to be Goldman's sole president and chief operating officer, received $7.4 million of distributions.

Such payments are considered investment returns and not included in annual compensation figures.

Last year Winkelried received a cash salary of $600,000, but no new stock or option awards. The bank said he earned $2.5 million from stock awards granted for prior years. Compensation overall fell to $3.4 million from $71.5 million a year before.

As part of the bank's $5 billion preferred stock investment from Warren Buffett's Berkshire Hathaway Inc (nyse: BRK - news - people ), Winkelried as a top executive officer can sell no more than 10 percent of his Goldman stock. These limits apply even in retirement.

Executive pay has become a lightening rod since the U.S. government stepped in to bail out the banking system last fall. Goldman in October received $10 billion of capital from the U.S. Treasury Department's Troubled Asset Relief Program, though the money came with executive pay caps.

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BLOOMBERG: Goldman Sachs Said to Lose Buffett’s Banker Trott

By Christine Harper

March 30 (Bloomberg) -- Byron Trott, the Chicago-based investment banker who advises billionaire investor Warren Buffett, is leaving Goldman Sachs Group Inc. after 27 years at the company, said two people familiar with the matter.

Trott, a 50-year-old vice chairman of investment banking, is leaving to start a merchant banking fund that will invest in and advise companies controlled by families or entrepreneurs, said one of the people, speaking on condition of anonymity because the plans haven’t been publicly disclosed. The fund aims to raise $2 billion, the person said.

Banks such as Goldman Sachs that have taken government money face tougher regulatory oversight and greater public scrutiny, which may drive top bankers and traders to leave, said Henry Higdon, managing partner at recruitment company Higdon Partners LLC. Jon Winkelried, Goldman Sachs’s co-president, resigned last month.

“Nobody’s having fun at these banks if they’ve taken a nickel of government capital,” said Higdon, who is based in New York. “The place to be over the next two years is going to be private companies. The guys with the confidence, who are true entrepreneurs, are going to start their own companies.”

‘Earns His Fee’

Trott didn’t reply to a phone call and e-mail seeking comment. Andrea Rachman, a spokeswoman at Goldman Sachs, declined to comment.

Goldman Sachs was the biggest and most-profitable securities firm until it converted to a bank in September, a week after Lehman Brothers Holdings Inc. went bankrupt. Goldman Sachs was among the first nine banks that received capital injections from the U.S. Treasury in October, receiving $10 billion. The government has since enacted laws that restrict compensation at banks that have taken government money.

Trott, who joined New York-based Goldman Sachs in 1982, helped line up a $5 billion capital injection from Warren Buffett’s Berkshire Hathaway Inc. in September that was later supplemented with a $5.75 billion sale of common stock.

Buffett, whose insurance and investing firm is based in Omaha, Nebraska, is such a fan of Trott’s that he has praised him in Berkshire Hathaway’s annual reports. “He understands Berkshire far better than any investment banker with whom we have talked and -- it hurts me to say this -- earns his fee,” Buffett wrote in 2004.

Buffett will invest in Trott’s new company, the Wall Street Journal reported on its Web site. Buffett didn’t immediately reply to a request for an interview.

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CNBC: Warren Buffett Plans Investment As Favorite Investment Banker Leaves Goldman Sachs - WSJ

Topics:Mergers & Acquisitions | Warren Buffett

University of Chicago
Byron Trott (File photo)

Warren Buffett tells the Wall Street Journal that Berkshire Hathaway plans to invest in a new firm to be created by one of the few investment bankers to ever win his respect.

Byron Trott is leaving Goldman Sachs to start his own merchant-banking firm to be called BDT Capital Partners.

Buffett tells the WSJ, "We'll have a modest partnership interest.. We will not be the big dog."

Buffett says people who have worked with Trott in the past will probably invest in his new fund. The Journal says the fund will invest in "family-controlled and entrepreneurial companies" and "could grow to about $2 billion."

Trott's departure won't disrupt Buffett's long-standing relationship with Goldman. Buffett tells the newspaper he's already met the person at Goldman who will "take care of me" after Trott's departure.

Trott worked closely with Buffett on Berkshire's investments last fall in Goldman itself and General Electric. He also played a key role on Berkshire's involvement with last year's $23 billion acquisition of Wrigley by Mars.

And back in his 2003 letter to Berkshire shareholders, Buffett wrote of Trott: "He understands Berkshire far better than any investment banker with whom we have talked and – it hurts me to say this – earns his fee."

Current Berkshire stock prices:

Berkshire Portfolio

Class A: [US;BRK.A 85300.0 -4300.00 (-4.8%) ]

Class B: [US;BRK.B 2780.0 -140.00 (-4.79%) ]


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Monday, March 30, 2009

WALL STREET JOURNAL: China's BYD Aims to Supply Battery Technology to U.S., European Car Makers

By NORIHIKO SHIROUZU

BEIJING – BYD Co., a fledgling Chinese auto maker, is in talks to supply its battery technology to other car companies in Europe and the U.S., Chairman Wang Chuanfu said in an interview.

If finalized, a deal could solidify BYD's growing prominence in the electric car market, after it surprised the automotive world by launching a heavily electrified plug-in car in December, ahead of more established foreign rivals.

Mr. Wang, BYD's top executive and founder, and other BYD officials declined to identify the companies it is negotiating with. Mr. Wang, in the recent interview, said only that BYD is negotiating with one U.S. auto maker and two in Europe about supplying lithium-ion batteries it produces in Shenzhen, where BYD is based.

Mr. Wang said the batteries it is considering supplying are the same ones used in the F3DM sedan, its plug-in hybrid car that it started selling to corporate fleet customers in China in December. That car hit the market, albeit in limited release, about a year ahead of a similar car being planned for a launch late this year by Toyota Motor Corp.

A deal to supply its batteries to other car companies could put BYD – a battery producer that began selling cars only in 2005 – in competition with battery companies with similar technology such as A123 Systems, a closely held company based in Watertown, Mass.

An executive at A123 Systems couldn't immediately be reached for comment.

Mr. Wang said BYD's advantage for foreign auto makers is its ability to produce lithium-ion battery cells at relatively low costs. Last year, a company controlled by investor Warren Buffett invested $230 million in BYD, chiefly because of BYD's cost-effective battery technology.

Concerns over gasoline shortages and global climate change have prompted a global race to commercialize affordable electric-battery cars and electrified plug-in hybrids. Those efforts have been limited largely by immature battery technology.

While lithium-ion batteries are seen as the technology that will ultimately work, its successful use has been hindered by its relatively high price, limited durability, and concerns about safety problems.

BYD says it has largely resolved those issues by turning to a safer, more cost effective technology called iron-phosphate-based lithium-ion.

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THE NATIONAL POST: How the world ignored Warren Buffett, and paid the price


Posted: March 29, 2009, 12:10 PM by NP Editor
, Kelly McParland

There are any number of lessons one could take away from reading The Snowball, Alice Schroeder’s masterful biography of Warren Buffett, but probably the most striking is how often in his long career he’s watched the world of high finance and investing do its best to destroy itself.

We read constantly that the current crisis is the worst in generations. That’s true, but not for lack of trying. Read The Snowball and you can’t help feeling the meltdown was not only inevitable but well deserved; that in fact Wall Street -- driven by a stunning combination of bottomless greed and chronic myopia -- has been striving to bring it about for decades, and has come close to succeeding on several previous occasions.

Saturday, March 28, 2009

GANNON INVESTING: See's Candy-Quality Without Compromise

27.9.08

William Ramsey, an executive at Blue Chip Stamps, stood in the office of Robert Flaherty as they both awaited a call. Moments earlier, Flaherty had attempted to persuade Warren Buffett, majority owner of Blue Chip Stamps, to consider purchasing See’s Candy, a popular West Coast candy maker. Buffett turned them down—up until then, he was used to buying boring businesses on the cheap: banks, textile mills and insurance companies. Ramsey however, thought See’s was a great buy, and desperately tried to get Buffett back on the phone. Their secretary finally got hold of Buffett at his home in Omaha. He had reviewed the numbers, and liked what he saw.

After consulting with his friend and business partner, Charlie Munger, Buffett was ready to make an offer. This would be Buffet’s biggest investment to date, and he wasn’t one to overpay for anything—the deal almost fell through during negotiations, but the sellers finally accepted Buffett's offer.

The final price was $35 per share. With one million shares outstanding and $10 million in cash on the books, the net purchase price was $25 million. Blue Chip Stamps now owned 67.3% of See’s Candy Shops, with the remainder purchased from about 2,200 public holders in the months after.

But one thing remained unfinished: who would run the company? Buffett made it clear upfront that he wouldn’t be calling the shots at See’s. At the suggestion of the previous owner, Buffett, Munger, and a friend named Rick Guerin met with Charlie Huggins—executive vice president and twenty-year veteran of See’s. After three hours of discussion, Buffett knew that Huggins was the man for the job.


The History

The first See’s Candy shop was opened in Pasadena, California in 1921 by Charles See and his mother, Mary See. Each made their own contributions: Mrs. See used the recipes she had created over the past 50 years of candy making; Charles had studied the methods of a successful chain of candy shops in their native Canada.

Many customers remember the stores for their signature black and white motif that started at this first store and was designed to resemble Mary See’s home kitchen. Under the leadership of Charles See, the company steadily grew throughout California. They successfully navigated the business through the Great Depression and World War II, when sugar was severely rationed and customers lined up around the block to buy See’s limited supply of chocolates. By the time Charles died in 1949, the company had 78 stores and two manufacturing plants: the original plant in Los Angeles and a second one in San Francisco.

Over the next two decades, See’s Candy was run by Charles’ two sons, Laurance and Harry See. The brothers See expanded the shops into neighboring states and grew the number of locations to over 150 by the end of the 60’s. Two years after the death of Laurance See, his younger brother Harry no longer wanted to run the business and decided to pursue other interests (he owned a vineyard in Napa Valley). After more than a half century of family ownership, See’s was put up for sale. One of the several interested parties was Robert Flaherty, investment advisor to Blue Chip Stamps.

The sale was finalized in 1972, and See’s Candy was now a subsidiary of Blue Chip Stamps. Not long after, Blue Chip would be folded into Berkshire Hathaway (BRK.B) and See’s would become one of the earliest members of Warren Buffett’s cash generating conglomerate.

At first, employees and customers were worried that the new owners would change See’s for the worst. When the purchase was publicized in the local papers, everyone knew who the buyer was, and people didn’t have a lot of respect for them (Blue Chip had recently been through an antitrust case). Charlie Huggins was in charge of the transition, and recalled that he spent a lot of time “… dealing with customers who were concerned, mad that the family had sold and now [they were] in the hands of a company that would ruin See’s.” Angry patrons would send hate mail—claiming the candy was bad, and See’s had somehow changed it. It took Huggins almost two years to convince loyal customers and employees that nothing had changed, and that product quality and customer service would be better than ever.

In the first year of operation under new ownership, See’s sold about seventeen million pounds of candy for just over $31 million. This number continued to grow steadily under the shrewd management of Charlie Huggins. Fourteen years after his promotion, Huggins remained modest. “Our candy is a third of the price of say, Godiva chocolates,” he told a local paper. “They do a wonderful packaging job, though. Consumers seem to think that if the box is beautiful, the candy inside must be just as good. But quality wise, we feel that we’re at least their equal.”

At the close of the twentieth century, See's Candies had expanded to over 250 black-and-white shops across the United States, a majority of which were located in California. Since the acquisition, this growth represented an average of over three successful store openings a year. Customers purchased 33 million pounds of candy annually, giving See's earnings of $73 million on $306 million in sales (to put those numbers in perspective consider that, at the time, 33 million pounds of candy equated to almost one-pound of candy per California resident).


The Manager

Charles N. Huggins regularly made inspections of See’s factories—calling workers by their first names and taste testing chocolates, carefully “measuring” their quality and consistency. Naturally, See’s encourages all employees to eat as much candy as they like. It is Huggins’ belief that any employee who loves a certain variety of candy will express that love in their work and ultimately to the customers.

Chuck was born in Vancouver, Canada and first began working at See’s in 1951, when he was 26 years old. His first supervisor was Ed Peck, the general manager in San Francisco. As the company expanded, Huggins continued to work his way up the ranks, earning the trust of the See family. By the time Huggins was handed the role of Chief Executive Officer in 1971, he had worked in various positions at the company for over two decades. Almost immediately, Warren Buffett knew that Huggins was the right man for the job: “It took me 15 seconds to decide to make Chuck CEO and President, and to this day I wonder why it took so long.” There is no doubt that without Charlie at the helm, See’s wouldn’t be where it is today.

Over the years Huggins led by the following management tenets: 1) Concentrate the efforts of all employees to attain ever-increasing excellence in customer service and product quality; and 2) Never compromise quality ingredients or service over profits. Commenting on his style of management, Huggins listed a number of traits that were essential to his success: the ability to solve problems, the desire to learn, curiosity, discipline, creativity, and patience.

Huggins was a “Level 5” leader, as characterized by Jim Collins in his book Good to Great. He was an insider who knew the business well and was fanatically driven toward results. He channeled ambition into the company, not himself, and blended personal humility with strong professional will. Asked to explain See’s business, Huggins said, “It’s about the customers. It’s about making sure the customer is pleased, whatever it may take, no matter how outrageous. … There are certain things we do inadvertently… where we dissatisfy the customer. And when that happens, we always admit that we blew it, and ask what we can do to make it right. And then we stand on our heads until we get that done.”


The Moat

Quality is one of the most important aspects of See’s advantage over competitors and a key element in the marketing of their products. See’s chocolates are all preservative-free, and each box has the date it was filled and location in which it was filled so that the customer can see that they are getting the freshest product. Ingredients from suppliers are carefully examined by quality assurance teams at the factories for microbiologic compliance and purity.

The See’s Candy brand is the moat that ensures See’s will continue to be the dominant chocolate producer on the West Coast for years to come. Commenting on these advantages, Charlie Munger says that “…in some businesses, the very nature of things is a sort of cascade toward the overwhelming dominance of one firm. It tends to cascade into a winner-take-all result.” Product quality is just one of the many contributors (albeit a very important one) to the brand—along with customer service, store image and the public’s mental perception of the product.

A few non-candy examples illustrate this point: Most people would much rather be seen drinking their latte from a cup brandishing the green Starbucks (SBUX) logo than from some other generic brand. A loving husband could probably find a diamond necklace for his wife a lot cheaper off the internet—but if he handed her a similar necklace encased in a robin’s egg blue box from Tiffany & Co. (TIF), she’d know that he loved her. And likewise, come February 14, your significant other won’t think twice about where that heart-shaped box of chocolates will come from—after noticing the See’s “Famous Old Time” Candies logo on the front, the box doesn’t even need to be opened.

Marketing plays a huge role in this perception. Customers know that the three-word motto “Quality Without Compromise” is not taken lightly at See’s. Buffett constantly reminded Charlie Huggins about what they were really selling—“Maybe the grapes from a little eight-acre vineyard in France are really the best in the whole world, but I have always had a suspicion that about 99% of it is in the telling and about 1% is in the drinking.”

In 1989, after an 8% year-over-year increase in pounds sold (a very high number for same-store growth); Buffett explained that shrewd advertising was the cause. That year, advertising expenditures had been increased from $4 million to $5 million. “When business sags,” says Buffett, “we spread the rumor that our candy acts as an aphrodisiac. Very effective. The rumor, that is; not the candy.

Another reason that See’s was able to grow so successfully throughout the years was their astute real estate planning. During the 1950s, population growth in California resulted in an even larger increase in suburban development.

It was during this period of suburban expansion that the modern day shopping mall was born. Laurance See recognized the potential of malls and expanded See’s into new developments locally, and for the first time, outside of California. For stand-alone stores, the See brothers would attempt to place them on the shady side of downtown roads, assuming that people are more likely to walk on that side of the street when it’s hot outside.

Throughout the years, See’s has been very careful not to expand too quickly and only open a location when it makes sense. “The ordinary company puts in too many stores,” says Charlie Munger. “You have this huge overhead you’re carrying through July and August, and you just can’t get well at Christmas. But See’s has always had the discipline of knowing their own business.

In hindsight, See’s would become one of Warren Buffett's most important investments. The company had all the traits that he would later look for when making a purchase: a family owned, well managed business with strong competitive ad¬vantages and little need for additional capital.

See’s Candies was a fantastic business. Buffett and Munger couldn’t have asked for much better. With Chuck Huggins, the See’s brand name, and the superior economics of the candy industry, they got the whole package for $25 million. But ultimately, the success of any investment comes down to the price paid relative to the value received. Was paying 12.5 times after-tax earnings justifiable?

In hindsight, the investment turned out to be more than acceptable. Assuming See’s Candy could have been sold in 1999 for the same 12.5x multiple, and factoring in the approximate cash that it distributed over the years, Berkshire Hathaway’s internal rate of return would be just under 35% (pre-tax). This is for a period of 28 years during which the S&P 500 returned 14% annually including dividends.

One can learn only so much by assessing investments through the rearview mirror. Nassim Nicholas Taleb, author of “The Black Swan,” says it best: “History seems clearer and more organized in history books than in empirical reality.” To attempt to avoid this retrospective distortion, I find it best to examine investments within the context of when they were purchased. In this situation, the evolution of Buffett and Munger’s investment methods played a key role in their decision to purchase See’s Candies.


The Goodwill

When Warren Buffett began his investing career, he paid little attention to qualitative factors in investment decisions. Buying tangible assets for much less than they were worth was his bread and butter. Benjamin Graham, Buffett’s mentor, played a large role in these views. Graham taught that investments should be made only when the business can be purchased at a large discount to its tangible value (hard assets like cash, inventory and property).

Toward the later years of the Buffett Partnership, Buffett began to move away from buying companies solely on a quantitative basis. In 1968, he wrote to his partners, “When I am dealing with people I like, in businesses I find stimulating (what business isn’t?), and achieving worthwhile overall returns on capital employed (say, 10-12%), it seems foolish to rush from situation to situation to earn a few more percentage points.” This transition was brought about by a combination of Buffett’s experience in dealing with struggling businesses, and the growth in his base of capital to invest. Other influences on this change of style were Philip Fisher, author of “Common Stocks and Uncommon Profits,” and Buffett’s partner, Charlie Munger. Munger has cited See’s role in the evolution of Buffett's investment thinking:

See’s Candy was acquired at a premium over book [value] and it worked. Hochschild, Kohn, the department store chain, was bought at a discount from book and liquidating value. It didn’t work. Those two things together helped shift our thinking to the idea of paying higher prices for better businesses.

Munger’s point was that it’s much easier to buy a good business and watch it grow, than to buy a deeply discounted but struggling business and spend time, energy, and more money setting it straight. When estimating the intrinsic value of a business, there are two categories of assets that must be valued: physical/tangible assets, and intangibles like economic Goodwill. Valuing the latter is the tricky part, and isn’t just a matter of checking the balance of “Goodwill” on the balance sheet. Buffett discussed the nature of economic Goodwill, using the See’s purchase as an example, in the 1983 Berkshire Hathaway Annual Report:

Businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.

When a company earns a market rate of return (or “cost of capital” in finance textbooks) on its invested capital, it should be worth the market value of its net tangible assets—no more, no less. But when a business like See’s Candy can sustain high returns on capital, it should be valued much higher than its tangible net-worth (depending on the extent of the excess returns). The difference between this tangible book value and true intrinsic value is what Buffett calls economic Goodwill. If it were recorded as an asset on the balance sheet, it would represent intangibles like See’s brand name, its “mind share” among customers, and other aspects of See’s competitive advantages (detailed in Part I). Unlike property and equipment, this asset requires little in the way of maintenance expenditures—as long as See’s keeps doing what they’re doing, economic Goodwill won’t degrade with time. With minimal reinvestment, this Goodwill should continue to produce excess profits well into the future.

Although never putting this concept fully into practice, Benjamin Graham was no stranger to economic Goodwill. In his book “Security Analysis,” Graham writes:

It may be pointed out that under modern conditions the so-called “intangibles,” e.g. goodwill or even a highly efficient organization, are every whit as real from a dollars-and-cents standpoint as are buildings and machinery. Earnings based on these intangibles may be even less vulnerable to competition than those which require only a cash investment in productive facilities. Furthermore, when conditions are favorable the enterprise with the relatively small capital investment is likely to show a more rapid rate of growth. Ordinarily it can expand its sales and profits at slight expense and therefore grow more rapidly and profitably for its stockholders than a business requiring a large plant investment per dollar of sales. [My emphasis]


The Growth

At the time of purchase in 1972, See’s Candy had $8 million in net tangible assets and after-tax earnings of $2 million, giving it a return on invested capital of 25%. To justify the $25 million price tag, See’s would have to not only sustain their excellent performance, but grow the business and generate sufficient free cash flows to fund future growth. Regarding the second criteria, See’s passed with flying colors. Growth in earnings was another issue, but let’s first examine the benefits of a high return on capital business.

Compared to a company that has a low or average return on its assets, See’s has the ability to grow sales with little need for additional capital. Even without growth, physical assets of any business will need to be replaced over time whether motivated by competition or continuous inflation. Sales growth through any method will eventually require a subsequent increase in working capital. And when this time comes, See’s will have to put only a small portion of its earnings back into the business—which yields greater free cash flow and hence more value to owners. At this point, the astute reader may ask: why not reinvest all the profits, and grow at a much faster rate than those with lower returns? Depending on the business, this is usually the preferable option. But at See’s, growth is more difficult (more below) and would come at the cost of sacrificing profit.

Buffett has commented that they’ve tried many times to put more money into See’s—but to no avail. Return on invested capital may continue to improve, but return on incremental capital invested is what matters most for a growing business. And with Warren Buffett allocating capital, current profitability won’t be sacrificed for diminishing rates of return. In the 1991 Berkshire Annual Report, Buffett talked about See’s and the allocation of its free cash flow:

For an increase in profits to be evaluated properly, it must be compared with the incremental capital investment required to produce it. On this score, See's has been astounding: The company now operates comfortably with only $25 million of net worth, which means that our beginning base of $7 million has had to be supplemented by only $18 million of reinvested earnings. Meanwhile, See's remaining pre-tax profits of $410 million were distributed to Blue Chip/Berkshire during the 20 years for these companies to deploy (after payment of taxes) in whatever way made most sense.

As mentioned in Part I, over a period of 27 years after the acquisition, See’s had an average of three net store openings a year (since then almost a fifth of total stores have been closed). This may sound like sufficient enough growth, but compare this to modern-day examples like Starbucks—which last year alone opened 2,199 stores. One cause of this discrepancy is the growth rate of each industry—unlike See’s, Starbucks practically created the market for their product and they continue to grow into it. (The market for premium chocolates is expected to reach $1.8 billion in 2008) The slow growth rate frustrated Buffett at times as he remarked that they “…regard the most important measure of retail trends to be units sold per store rather than dollar volume.” Despite this volume problem, See’s was able to grow earnings in other ways: the most important of them being the ability for the “dollar volume” to rise whilst the unit volume remained steady.

The most basic determinates of revenue are price and volume. To grow sales and consequently earnings, you’ll have to either raise prices, or sell more products. Early on Buffett realized that See’s was well suited to grow through the former method. “In our See’s purchase,” he commented in the 1991 Annual Report, “Charlie and I had one important insight: We saw that the business had untapped pricing power.” Customers aren’t shopping at See’s because of its low prices. As long as quality is uncompromised, paying a dollar more than you did last Valentine’s Day isn’t a problem. If costs of ingredients go up, prices go up. Inflation? Not a problem at See’s. This ability to continually raise prices without interruption in unit sales is a tremendous advantage over products in other industries. Over the years, these price increases have supplied a majority of the close to 9% compounded growth in earnings—despite the second-rate growth in store base and unit volume.

Advertising is another way to maintain and grow a business’s Goodwill. One advantage that See’s and other candy companies have is they can distribute marketing costs over a shorter amount of time. Instead of selling ads throughout the year, the holiday season is all that’s necessary. Over half of annual chocolate sales are made between Thanksgiving and New Year’s Eve. The month of December alone accounts for about 90% of annual profits. During Christmas and Easter, the See’s factory in San Francisco gets several tanker trucks full of melted chocolate on a daily basis (See’s was the first candy company to come up with this method of delivery).

See’s Candy was the ultimate example of paying a fair price for a quality business (it’s when people are willing to pay any price for a quality business that they get into trouble). The qualitative factors are many, but the combination of high returns on capital and steady growth through price increases played a key role in the success of the investment. So the next time you’re given the opportunity to invest in a business of similar quality to See’s—at a price of only twelve-and-a-half times earnings—don’t hesitate to back up the truck.

Max Olson runs an investment partnership that follows a deep value approach to investing. His articles focus on general principles of value investing as well as specific applications of those principles.

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VALUE INVESTING RESOURCE: See's Candy: A Magic Formula Stock from 1972?

Monday, March 3, 2008

The passage below from Mr. Buffett's 2007 Letter to Berkshire Hathaway shareholders is particularly interesting:


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.)

Some thoughts...

Re: "2% growth rate in volumes"
  • Yet, the growth in revenues is materially above 2% per annum:
    • Sales growth comes from raising prices every Valentine's Day with minimal increase in invested capital, suggesting extraordinarily high return on incremental capital - that are (a) sustainable, and (b) scalable to even greater levels.
      • Roughly 60% pretax return on capital, circa 1972
      • Roughly 200% pretax return on capital, circa 2007
    • Incremental revenues are largely free cash flows.
How did Mr. Buffett manage to turn a $25 million investment in 1972 into a machine that's generated $1.35 billion of free cash flows?

California Joe just won't tell California Jane on February 14:


  • Honey, I love you so much this year that, for the first time, I bought the cheaper chocolate bar, and the dollar I saved shows my true love for you. Happy Valentine's Day!

A far better approach is:

  • Honey, I hope you don't mind that I spent an extra dollar this year; this is a reminder of our first date and your love is priceless. Happy Valentine's Day!

See's Candy is effectively a (rising) royalty on love men pay, annually, in the state of California.



Ultimately, per Mr. Buffett:


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.

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MOTLEY FOOL: 3 Reasons to Invest in American Express Today




No matter what's going on in the market or a specific company's history, there are always reasons to consider buying shares in a business. After all, some of the best opportunities in stocks are born from historically bloody times.

Motley Fool CAPS hosts a boatload of opinions from more than 130,000 members on more than 5,300 stocks, giving good reasons to own -- or sell -- a stock.

In the case of credit card issuer American Express (NYSE: AXP), a total of 2,865 members have given a bullish or bearish opinion on the company. Scouring the detailed information packed in pitches and other comments on the company, here are three of the top reasons to buy American Express today:

In value territory: Stocks of financial giants like American Express, Wells Fargo (NYSE: WFC), General Electric (NYSE: GE), and US Bancorp (NYSE: USB) are trading around multi-year lows and many investors have been waiting for an opportunity like this to buy a well established blue chip for a long term investment.

Reducing risk: American Express bears more risk than Visa (NYSE: V) or MasterCard (NYSE: MA), but the company is taking proactive steps to reduce its risk exposure. Preparing for more tough times ahead, the company is closing inactive accounts, raising rates on some of its credit card portfolio and offering incentives for high risk customers to close their accounts.

Backed by Buffett: Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) owns 13% of American Express and the Oracle of Omaha recently gave his bullish opinion of the company stating that he expects it to be around forever. Investors have followed Buffet's principles in the past where he has profited immensely from investments in good companies when they've been in temporary trouble, and see the chance to do so again with American Express.

Of course, there's a lot more devil in the details of these buy-side opinions, which is why CAPS is such a great resource to check and balance your own analysis. You can read the bullish and bearish sides to every stock. To see what the very best CAPS members are saying now about American Express, just click on over to Motley Fool CAPS and have a look -- it's all free, and your opinion's welcome, too.

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