Dear Reader,
Attached is a recent list of stocks that passed value screens (e.g. low multiples of earnings, tangible assets, etc.) but don’t meet our investment criteria - and our reasoning.
This may help you avoid some ‘value traps’, and stocks that aren’t sufficiently attractive compared to opportunities available today.
For reports of stocks that pass our quantitative and qualitative standards:
Berkshire 2024 Letter
The annual Berkshire letter was released last week. Notable quotes below (for context), and our notes - bold emphasis is ours:
Low-risk Japanese investing
Berkshire borrowed Japanese Yen at low fixed rates to invest in a group of five Japanese conglomerates paying out far higher amounts in dividends:
"A small but important exception to our U.S.-based focus is our growing investment in Japan. It’s been almost six years since Berkshire began purchasing shares in five Japanese companies that very successfully operate in a manner somewhat similar to Berkshire itself. The five are (alphabetically) ITOCHU, Marubeni, Mitsubishi, Mitsui and Sumitomo. Each of these large enterprises, in turn, owns interests in a vast array of businesses, many based in Japan but others that operate throughout the world. 10 Berkshire made its first purchases involving the five in July 2019. We simply looked at their financial records and were amazed at the low prices of their stocks. As the years have passed, our admiration for these companies has consistently grown. Greg has met many times with them, and I regularly follow their progress. Both of us like their capital deployment, their managements and their attitude in respect to their investors. Each of the five companies increase dividends when appropriate, they repurchase their shares when it is sensible to do so, and their top managers are far less aggressive in their compensation programs than their U.S. counterparts.
Our holdings of the five are for the very long term, and we are committed to supporting their boards of directors. From the start, we also agreed to keep Berkshire’s holdings below 10% of each company’s shares. But, as we approached this limit, the five companies agreed to moderately relax the ceiling.
Over time, you will likely see Berkshire’s ownership of all five increase somewhat. At year-end, Berkshire’s aggregate cost (in dollars) was $13.8 billion and the market value of our holdings totaled $23.5 billion. Meanwhile, Berkshire has consistently – but not pursuant to any formula – increased its yen-denominated borrowings. All are at fixed rates, no “floaters.” Greg and I have no view on future foreign exchange rates and therefore seek a position approximating currency-neutrality. We are required, however, under GAAP rules to regularly recognize in our earnings a calculation of any gains or losses in the yen we have borrowed and, at year-end, had included $2.3 billion of after-tax gains due to dollar strength of which $850 million occurred in 2024. I expect that Greg and his eventual successors will be holding this Japanese position for many decades and that Berkshire will find other ways to work productively with the five companies in the future. We like the current math of our yen-balanced strategy as well. As I write this, the annual dividend income expected from the Japanese investments in 2025 will total about $812 million and the interest cost of our yen-denominated debt will be about $135 million."
An example of low-risk investing, and note the margin of dividends over interest payments - ~6x cover.
Though we can't borrow like Berkshire to buy stocks, we do try to implement its low-risk investing style in all our reports.
Attitude to underwriting risk
Buffett outlines the appropriate attitude to underwriting insurance risk - but this is also relevant to underwriting equity risks i.e. investing in a diversified group of bargain stocks.
"No private insurer has the willingness to take on the amount of risk that Berkshire can provide. At times, this advantage can be important. But we also need to shrink when prices are inadequate. We must never write inadequately-priced policies in order to stay in the game. That policy is corporate suicide. Properly pricing P/C insurance is part art, part science and is definitely not a business for optimists. Mike Goldberg, the Berkshire executive who recruited Ajit, said it best: “We want our underwriters to daily come to work nervous, but not paralyzed.”"
...
"We are not deterred by the dramatic and growing loss payments sustained by our activities. (As I write this, think wildfires.) It’s our job to price to absorb these and unemotionally take our lumps when surprises develop."
Investing in bargain stocks requires courage after a thorough analysis of risks. Moreover, diversification helps in taking losses unemotionally - and carry on.
We focus on such analysis in our reports, and provide our readers with a sufficient number of undervalued stocks for adequate diversification.
Management fidelity
"Moreover, Greg, our directors and I all have a very large investment in Berkshire in relation to any compensation we receive. We do not use options or other one-sided forms of compensation; if you lose money, so do we. This approach encourages caution but does not ensure foresight."
Option and warrants awarded to employees take away from shareholders' wealth. Though they're conditioned on performance, the specific structuring matters.
Since it's a common feature in public companies, analyzing the extent of option issuance is essential before investment - something we do in our reports.
Personal Finance - Reinvestment of Savings
Reinvestment of savings is essential for financial growth - for individuals and countries:
"One way or another, the sensible – better yet imaginative – deployment of savings by citizens is required to propel an ever-growing societal output of desired goods and services. This system is called capitalism. It has its faults and abuses – in certain respects more egregious now than ever – but it also can work wonders unmatched by other economic systems. America is Exhibit A. Our country’s progress over its mere 235 years of existence could not have been imagined by even the most optimistic colonists in 1789, when the Constitution was adopted and the country’s energies were unleashed. True, our country in its infancy sometimes borrowed abroad to supplement our own savings. But, concurrently, we needed many Americans to consistently save and then needed those savers or other Americans to wisely deploy the capital thus made available. If America had consumed all that it produced, the country would have been spinning its wheels."
...
"In a very minor way, Berkshire shareholders have participated in the American miracle by foregoing dividends, thereby electing to reinvest rather than consume. Originally, this reinvestment was tiny, almost meaningless, but over time, it mushroomed, reflecting the mixture of a sustained culture of savings, combined with the magic of long-term compounding."
In equities, even if you consume all your dividends, your share of retained earnings are automatically reinvested by management - and this can turn into significant sums over time.
Equities
Buffett makes clear his preference for equities over cash:
"Despite what some commentators currently view as an extraordinary cash position at Berkshire, the great majority of your money remains in equities. That preference won’t change. While our ownership in marketable equities moved downward last year from $354 billion to $272 billion, the value of our non-quoted controlled equities increased somewhat and remains far greater than the value of the marketable portfolio. Berkshire shareholders can rest assured that we will forever deploy a substantial majority of their money in equities – mostly American equities although many of these will have international operations of significance. Berkshire will never prefer ownership of cash-equivalent assets over the ownership of good businesses, whether controlled or only partially owned. Paper money can see its value evaporate if fiscal folly prevails. In some countries, this reckless practice has become habitual, and, in our country’s short history, the U.S. has come close to the edge. Fixed-coupon bonds provide no protection against runaway currency. Businesses, as well as individuals with desired talents, however, will usually find a way to cope with monetary instability as long as their goods or services are desired by the country’s citizenry. So, too, with personal skills. Lacking such assets as athletic excellence, a wonderful voice, medical or legal skills or, for that matter, any special talents, I have had to rely on equities throughout my life. In effect, I have depended on the success of American businesses and I will continue to do so."
For smaller investors, attractive opportunities are almost always available and it's usually smarter to stay fully invested throughout their investing lifetime - and live off the dividends - rather than hold substantial amounts of cash. (If you know equities are going to do well over the next 15 years, why fool around with market timing and holding cash in low-yielding accounts.)
Management Honesty
"During the 2019-23 period, I have used the words “mistake” or “error” 16 times in my letters to you. Many other huge companies have never used either word over that span. Amazon, I should acknowledge, made some brutally candid observations in its 2021 letter. Elsewhere, it has generally been happy talk and pictures. 1 I have also been a director of large public companies at which “mistake” or “wrong” were forbidden words at board meetings or analyst calls. That taboo, implying managerial perfection, always made me nervous (though, at times, there could be legal issues that make limited discussion advisable. We live in a very litigious society.)"
It's rare for managements to admit errors but a frank discussion of business difficulties is useful for investors. Furthermore, in our view, when management pays out meaningful amounts in dividends, a lot of flaws can be forgiven.
Scuttlebutt
"I first heard of Forest River – the Indiana company Pete founded and managed – on June 21, 2005. On that day I received a letter from an intermediary detailing relevant data about the company, a recreational vehicle (“RV”) manufacturer. The writer said that Pete, the 100% owner of Forest River, specifically wanted to sell to Berkshire. He also told me the price that Pete expected to receive. I liked this no-nonsense approach. I did some checking with RV dealers, liked what I learned and arranged a June 28th meeting in Omaha. Pete brought along his wife, Sharon, and daughter, Lisa. When we met, Pete assured me that he wanted to keep running the business but would feel more comfortable if he could assure financial security for his family."
An example of Buffett's 'scuttlebutt' approach when buying a controlling stake in a business.
Business Talent
"One further point in our CEO selections: I never look at where a candidate has gone to school. Never! Of course, there are great managers who attended the most famous schools. But there are plenty such as Pete who may have benefitted by attending a less prestigious institution or even by not bothering to finish school. Look at my friend, Bill Gates, who decided that it was far more important to get underway in an exploding industry that would change the world than it was to stick around for a parchment that he could hang on the wall. (Read his new book, Source Code.) Not long ago, I met – by phone – Jessica Toonkel, whose step-grandfather, Ben Rosner, long ago ran a business for Charlie and me. Ben was a retailing genius and, in preparing for this report, I checked with Jessica to confirm Ben’s schooling, which I remembered as limited. Jessica’s reply: “Ben never went past 6th grade.” I was lucky enough to get an education at three fine universities. And I avidly believe in lifelong learning. I’ve observed, however, that a very large portion of business talent is innate with nature swamping nurture. Pete Liegl was a natural."