Berkshire Hathaway (BRK.A, BRK.B) was in the news this week, and the Oracle continues to impress: on Oct. 1, Mars repaid $4.4 billion of subordinated notes that were sold to Berkshire in 2008 to help finance the company’s $23 billion acquisition of Wrigley’s; the notes were repurchased at 115.45% of their face value – good for $680 million in profit for Berkshire (on the repurchase price alone).
One WSJ article highlighted a few of the other timely investments that Buffett made in the depths of the financial crisis:
“In 2008, Berkshire invested $5 billion in Goldman Sachs Group Inc. (GS) at the height of the financial crisis. The deal gave Berkshire warrants conferring the right to buy 43.7 million Goldman shares at below-market prices, but was amended in March, allowing Berkshire to opt for fewer shares without any cash outlay. The deal was completed earlier this week, making Berkshire Goldman's sixth-largest shareholder with a stake of about $2.1 billion.
Berkshire also made investments in General Electric Co. (GE), Bank of America Corp. (BAC) and others. Such stakes, classified as 'other investments' in Berkshire's filings, totaled $17.2 billion as of the end of June.”
Many people lament that they could never get deals like Buffett (even though all you need to do is purchase Berkshire common); only he can get these sweetheart deals, they proclaim – as if the companies on the other side of the transaction are parting with hundreds of millions of dollars just to be pals with the Oracle.
In an interview, Buffett made it as clear that such deals are not a prerequisite for success:
"In terms of simple profitability, an average investor could have done just as well investing in the stock market if they bought during the panic period… You make your best buys when people are overwhelmingly fearful."
I thought I would take a closer look at that premise. Since Buffett put nearly $15 billion to work in September and October of 2008 (with the majority of the remainder near the market bottom in February – April 2009), that’s the period I’ll look at. By the way, you could find many examples that look quite interesting, from Wells Fargo (WFC) to American Express (AXP). I’m going to assume that an investor only understands (or felt comfortable with) the most basic financial analysis, and is petrified of any company that was in any related to the financials that were gyrating wildly day after day in 2008 and 2009 (and understandably, the leverage left many saying "no thanks").
Let’s start with a common favorite: Coca-Cola (KO). In October 2008, KO traded in the low-mid $20s per share; it closed September around $26 and October around $22, so let’s split the difference. At the time (per a 10-Q released on Oct. 23), the company had roughly 4.65 billion shares out (split adjusted), for a market cap of $111 billion at our average price; the stock would eventually bottom below $20 per share.
By the way, there was never any question about the company’s cash situation: In addition to a current ratio slightly above 1, the company had generated nearly $5.7 billion in operating cash flow through the first nine months of the year – ahead of the pace for 2007. An investor who purchased at our September/October price of $24 is currently sitting on a 55% gain before dividends – a five-year CAGR around 12% after dividends. This is despite watching your investment plummet approximately 20% in the first six months after your initial investment (a perfect example of the idiocy of stop-loss orders).
Some people might say that the current ratio slightly above 1 doesn’t leave much room for error (assuming you forget the billions in cash generation); if you’re a bit more concerned about the balance sheet, why not try out Microsoft (MSFT). In the company’s 10-Q filed Oct. 23, Microsoft held just under $21 billion in cash; the company’s current assets, which totaled $37.2 billion at the time, exceed total liabilities by more than $5 billion. In the three months covered in the 10-Q, Microsoft had earned $6 billion in pre-tax income. To put this in perspective, the entire company had a valuation of under $130 billion at its bottom tick – equal to just over 20x pre-tax earnings for a single quarter. Anyways, our investor who bought in September/October of 2008 paid in the low-mid $20s per share, and is current sitting on a gain of between 30% and 50% before dividends.
One last example: Let’s say you recognize the fact that you belong in index funds and do as such. You figure that most of the companies in the S&P 500 won’t go bankrupt, and decide to purchase into the index. The S&P 500 closed September around 1100, and was down mid-teens by the end of October to below 1000; today, with the index over 1650, you are looking at a 50% increase in your investment from the September close – and nearly 75% at the October close.
No matter what happens with the politicians in the coming weeks, they will continue to create periods of uncertainty and concern in the future; the global economy will have spurts of seemingly endless prosperity, only to be followed by what looks like the end of the world. The only thing that is certain is that we don’t know what lies around the next corner.
It’s uncertain how earnings will shake out in any given quarter or year; if you’re an investor, I’d argue that such information has limited value anyways. Deciphering which companies have the highest likelihood of earning a sufficient return on their invested capital to justify investment over a period of many years will prove much more meaningful; if you pursue this with conservatism and patience, I think the chances of success are quite high - much higher than attempting to out-guess the largest investment banks in the world (who seem quite cozy with many management teams). When greed and fear are the order of the day, opportunity abounds for the prepared.
I’ll end with a quote from Buffett that sums this up nicely:
“The idea that you try to time purchases based on what you think business is going to do in the next year or two, I think that’s the greatest mistake that investors make - because it’s always uncertain. People say it’s a time of uncertainty; it was uncertain on September 10th, 2001, people just didn’t know it. It’s uncertain every single day. So take uncertainty as part of being involved in investment at all.”
About the author:
I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.