Warren Buffett Is Back in the Saddle
Legendary investor Warren Buffett reassured investors that he's at the top of his game. So says Timothy Vick, senior vice-president of Sanibel Captiva Trust -- a money management firm based in Sanibel Island (Fla.) that runs about $300 million -- and author of How to Invest Like Warren Buffett.
Vick was one of the thousands of shareholders who flocked to Omaha for the widely watched Berkshire Hathaway (BRK.A) annual meeting (see BW Online, 5/8/06, "Under Warren Buffett's Big Top"). He came away impressed with Buffett's energy and confident that the company is in good hands. Buffett's acquisition of an 80% stake in Iscar Metalworking, an Israeli maker of metal-cutting equipment, also shows that he's on the prowl for good values.
Karyn McCormack of BusinessWeek Online recently spoke with Vick about what he learned at Buffett's meeting, which large-cap stocks he's buying, and why the market may have trouble rising from where it is now. Edited excerpts from their conversation follow.
What did you take away from Buffett's shareholder meeting?
At the meeting, I was a lot more impressed this year than in 2005. I think Buffett went out of his way to reassure investors that he's at the top of his game. He's looking for some good acquisitions for us, and the company will be in good hands when he leaves. Those are the two overriding concerns for investors over the past few years and the chief factors holding down the [Berkshire] share price.
I was very glad that he named Bill Gates to the board of directors, and [glad] to see Gates personally purchase more than $300 million worth of Berkshire stock. Anyone who went to the meeting and had a chance to see Gates make public appearances would see he's very enthused to be in Buffett's culture and he will be around for a long time. From that perspective, shareholders who are looking for continuity will be reassured that someone of Bill Gates' stature will be carrying on Buffett's culture for the next 25 to 30 years.
I think it lends credibility, or at least assures younger investors that see most of Berkshire's board members are in their 70s, and...80s, and wonder what will happen when Buffett and Charlie Munger are no longer with us. Beyond that, Buffett spent a lot of time addressing continuity in management -- assuring us that management will be in place. I got the impression that Berkshire could skip a beat for a year or two, particularly in making new acquisitions, but can get in stride after that.
When will Buffett retire?
It's still up in the air when Buffett will retire. He'll stay in control until he dies, or he requests the board [to let him step down]. That was very important to shareholders. Last year, I got the impression he was winding down, as he was frustrated with market conditions. He had stepped down from board of Gillette (G), and he was about to step down from the board of Coca-Cola (KO).
Last year he was dealing with the death of his wife. This year he was much more energetic and showed zeal for the business. He had a large fantastic acquisition that made him giddy about prospects for the next few years. This year we saw the Buffett of old, only with a few more gray hairs.
Is Buffett still betting on a falling dollar?
He has pared back in terms of shorting the dollar. That's partly because the cost of making that transaction has risen significantly along with market volatility. His logic is dead on: If the country continues to run a trade deficit and inflation pressures pick up, then the forces are for the dollar to fall. The thing that could stop that is rising interest rates.
I think it's interesting the way he has transitioned from that bet. He started shorting the dollar and buying foreign currencies a year or two ago. Now it seems the way to play the falling dollar is by purchasing foreign companies.
Yes, Buffett announced a big acquisition right before the meeting.
He acquired [a major stake in] Iscar Metalworkings for $4 billion in cash, getting a quality family-owned company at a cheap price. It really is an indirect currency move for him. In one fell swoop, he gets rid of the cash on the balance sheet that investors have been complaining about, and trades $4 billion in depreciating dollars for assets denominated in foreign currencies.
The purchase of Iscar reminded me of how he structured General Re in 1998. It was a way to make a macroeconomic bet. He swapped overvalued Berkshire stock for essentially a huge portfolio of bonds before rates went down. This way, he cut his exposure to an overvalued stock market and rode gains in the bond market. With Iscar, he's hedging Berkshire's balance sheet against rising interest rates and a falling U.S. dollar -- it's a pretty smart move.
Is Buffett planning more acquisitions?
He said he was in talks to buy a $15 billion company, but said it's unlikely to happen and that he's still in those talks. He also said he'll be looking overseas for more companies like Iscar. He said U.S. companies are generally too high priced. Remember, with the size of Berkshire, he needs a big acquisition to move the needle, or boost the company's earnings.
[Berkshire] has the unique problem of generating $100 million in cash flow every week, on average. This is worlds away from the cash flow he had 10 years ago. It's the price of success. This means he has to find acquisitions. He's trying to find 10% to 15% returns so he's been sitting on the cash -- that's the reason the share price has been held back. Market conditions have taken away his ability to get high rates of return on cash flow.
How are you putting money to work these days?
We look at the markets very much the way Buffett does. A lot of assets have reached high prices. This applies to oil, natural gas, commodities, small caps -- everything has been bid up. A lot of value investors like us are putting money into large-cap value stocks and growth stocks that have been left behind. This brings us to companies such as Johnson & Johnson (JNJ), Microsoft (MSFT), Washington Mutual (WM), Wal-Mart (WMT), eBay (EBAY), Wells Fargo (WFC), First Data (FDC), Costco (COST), Medtronic (MDT), Fifth Third Bancorp (FITB), American Express (AXP), and Cisco (CSCO).
Their p-e ratios have contracted significantly over the last five years. In cases like Wal-Mart, and even Dell (DELL) and Anheuser-Busch (BUD), they're priced relative to their earnings where they were 10 years ago. Sales and earnings won't grow at the same rates as in the '90s, but you can still obtain share price growth of 9% to 12% in an environment when the S&P 500 may grow 6% to 8%.
Will that give you much of an edge?
I don't think people should turn their noses up at 10% to 12% stock gains. Many institutional investors still think 20% returns can be obtained, and they're chasing returns around the world. We've seen it with housing, energy, commodities -- that money is going to move out and will find another sector. That's what happened with small stocks. No one is going to make further grand slams on these sectors now.
I think we're in an environment where people should get used to lower returns. Instead of chasing yesterday's winners, hoping for a 20% return, they should look for 8% to 9% returns on average and try to cherry pick ones that can move them up to 10%.
Are you buying any other stocks?
We're finding a few turnaround situations -- companies that have fallen in price because of missing earnings or the valuation has come down. Getty Images (GYI) has fallen $30 in price in the last month or so. It owns the images you see in newspapers. It's a strong moat business that has given the company good growth. This is one we're buying now -- it's a little pricey but it has a nice franchise.
Chico's (CHS) recently fell sharply after preannouncing a poor quarter and disappointing same-store sales. It was bid up well above 40 times earnings and is now down to a more reasonable price. If it can get its act together, it should be able to post growth of 20% a year. I think investors could get very similar returns on the stock.
I would buy Berkshire, especially in light of its earnings and acquisition news. At $2,900 for the B shares (BRK.B), they're a good value. You're buying an insurance company for 1.4 times book value, which is, by itself, pretty attractive given the level of profitability. It's also holding $815 in cash per B share on the balance sheet, so you're getting all the operating companies and the equity investments for about $2,170 a share.
What do you think of the market near-highs not seen in six years?
It's good and bad. It's not firing on all eight cylinders now. It's true the Dow is near six-year highs, but the Nasdaq and S&P 500 are lagging. That's because the Dow has industrials, and the market is valuing highly industrials and exporters that are still profiting from worldwide economic and spending growth. But beyond those companies, there aren't a lot of companies hitting highs right now.
The market is also getting more fearful of interest rates. Higher long-term rates will cause stocks to fall. If interest rates move up, we may be in a multi-year period where p-e's contract -- causing stock prices to grow slower than earnings. That's why you want to latch on to a growth company first and foremost, but also you want a company that can expand its p-e ratio. That way you get the double-whammy.