Newsletter - January 28th, 2023

Dear Reader,

Attached is our latest list of apparently cheap stocks generated from basic value screens (low p/e, ev/ebitda, debt/equity, etc.), which don’t meet our investment standards - and our reasoning.

This may help you avoid a few ‘value traps’ or stocks that aren’t sufficiently attractive compared to the opportunities available today.

For reports of stock ideas that pass our quantitative and qualitative standards, join at the link below:

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BERKSHIRE AGM NOTES

We've been re-viewing Berkshire AGM videos this week and compiled a few notes that may be useful to you - arranged by topic (and videos are time-stamped for your ease of reference):

Exploit the Gambling Impulse

"The gambling impulse is strong" and this has been true throughout the stock market's history. It's the "pathological" nature of stock speculation as Ben Graham once said.

"They've gone to great lengths to come out to do something mathematically unintelligent, and they knew it was unintelligent, and they couldn't do it fast enough ... This is the land of opportunity."

"Nine out of ten so-called investors - and this includes the big institutions - are really speculators. This is fortunate, because it means the tenth can make a decent profit." (Ben Graham in July 1976)

Encouraging words for investors. The idea of exploiting the gambling/speculation inherent in markets gets our juices flowing - a bookmaker's approach to markets.

This general speculative attitude is likely to be a continuing source of profits as long as humans are accountable for trading results (regardless of algorithmic trading or the level of AI in markets).

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An Important Qualitative Trait

A good reminder that once strong competitive advantages are identified, it's the lack of change that's the important qualitative factor in an investment purchase of stocks - or "stability" as Ben Graham wrote in Security Analysis.

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Don't Expect Management to Change

On the subject of change, it's also wise not to expect management to change - accept the warts going in, and invest only if you're comfortable at the price you get in.

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A Group Approach

As Warren is well known for his concentration, we find it insightful when he does take a group approach to stocks.

Below, referring to the difficulty of evaluating individual pharmaceutical companies in 1993 (when Clinton introduced healthcare reforms that battered pharmaceutical stocks), he says he should've taken a basket approach to the pharmaceutical industry as a whole.

A group approach just seems so much simpler and sensible to us. Why look for the needle when the haystack is very cheap.

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The Junk Bond Approach to Stocks

Buffett's foray into distressed junk bonds in 2002 is fascinating to us because it's similar to Ben Graham's approach to common stocks. (Also note the Level 3 question right after)

"We expect losses in junk bonds but with an overall probability of decent results." "No large margins of safety in their operations, managements that are suspect"

"It's like being an insurer of substandard risks, you'll have more accidents but you can charge a premium that makes it work out."

To be sure, Warren buys superior risks in common stocks and expects very little in losses but it is interesting to see him invest in junk bonds despite knowing little about the telecommunications industry.

As small investors, it's a lot simpler to take the junk bond approach to common stocks as Ben Graham advised - but that requires wide diversification as there will be losses in individual cases.

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"Getting enough for our money"

Buffett on his inability to time and simply looking for enough for his money when investing - investing needn't be complicated to be successful.

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Average earning power

Below, Buffett discusses his thinking before Berkshire's Precision Castparts investment - he was assessing price relative to average earning power (which didn't materialize in this case):

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Buffett's Purchase Yields

Generally Buffett is coy about the earnings yields of his purchases, so it is rare and insightful when he discloses them. The yields he is able to invest at is certainly a function of his size; as small investors, we can obtain much better bargains - but it's interesting to see his thresholds:

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REITS yielding 11-12%:

Purchases were made around 1999-2000

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10% pre-tax threshold in 2003:

As a cut-off in 2003, and he then selects the most attractive among the list.

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10% after-tax threshold in 1994:

In a world of 7% long-term bond yields.

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Airline purchases at 7-8x earnings:

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Internal lending rates of ~15% pre-tax:

Warren charges subsidiaries for capital retained and credits them for capital released. This subject is little discussed - but he used to charge rates of 15% pre-tax (9-9.5% after-tax) in 1995 to reflect his opportunity costs at the time:

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Until next time, Have a great week!