Holly: Hi. Welcome to the GuruFocus podcast. I’m Holly, and I am the editor of GuruFocus, and I am here with Wally Weitz. He is the owner of the Weitz Investments, and that’s in Omaha, where another famous investor you may have heard of is also, an investor, Warren Buffett (Trades, Portfolio).
He manages four billion there at his investment firm, and we’re very fortunate to be able to speak with him today. Hi, Wally. How are you?
Wally: I’m fine. I’m fine.
Holly: Great, great. Welcome. Okay, well, we took some reader questions, but we also have some from GuruFocus, and so I guess we’ll go ahead and get the conversation started here.
Oh, and I should say, Wally, he manages two of the funds at Weitz Funds, even though all of the funds have his influence. He is a bottom-up stock picker who looks at companies as if they’re a business, and he looks for companies that are going to have a margin of safety of around 30%. So he manages the Partners III Fund and the Hickory Fund with a co-manager as well on that second one. So, okay.
Wally: And also Partners Value Fund.
Holly: Oh. I’m sorry. Okay.
Wally: I co-manage that with Brad Hinton.
Holly: Okay. Great. Sorry about that. Okay, well, Wally has a very interesting story. He found Ben Graham in high school and he bought his first stock when he was 12, and so I wanted to start from the beginning and find out how finding Ben Graham changed your perspective back then in how you invested stocks?
Wally: Okay. Well, I did start when I was 12, reading a little book called How to Buy Stocks by Louis Engel after meeting a stockbroker and being encouraged to do a little reading. But as I went through, I bought stocks basically on other people’s recommendations and various reasons that you’d not want to copy, and then in junior high I was in a stock market club, and was introduced to charting and technical analysis, and at one point I kept 100 charts a day.
Holly: Oh, my.
Wally: You know, when the red line crossed the blue line and something broke out, I’d buy a few shares, and it was very cheap tuition in retrospect because a $50.00 loss to a teenager was tragic.
Holly: [laughter] Of course, [inaudible] back then.
Wally: But yeah, I got over the charting idea when I stumbled on Ben Graham, and actually I read his main textbook, Security Analysis first, and then The Intelligent Investor later. That’s a lot more approachable book, but his whole idea that businesses were living organisms that grew and shrank and had good and bad things happen, and you could tell-- with a little work you could figure out what a private investor might be willing to pay for the whole business. And then if you had the discipline to wait for the stock price to be available at a deep discount to that business value, then the odds of success were really good. Nothing was ever for sure, and you mentioned a 30% discount in the introduction there. I’d like a deeper discount than that.
It’s just not been available in the market in recent years.
Holly: Right. Yeah, especially recently. So you got this new philosophy and you bought Berkshire (BRK.A, Financial)(BRK.B, Financial) really early on, and I was wondering what made you do that. And you mentioned also that it’s kind of evolving into a different company right now. What do you think about that?
Wally: Well, yeah. When I was still in New York, I worked in a small brokerage firm for three years in New York and one of the partners there, Frank Monahan, I brought him a stock idea and it happened to be a company where Warren was on the board, and Frank knew of Warren and said, “When you move out to Omaha, pay attention to that guy.”
Holly: [laughter] Really?
Wally: I went to my boss at the brokerage firm I went to work for in Omaha, was a good friend of Warren’s, and so he made sure also that I paid attention to Warren, and we went to the-- I went to my first official meeting of Berkshire probably in 1973, and it was in the National Indemnity lunchroom, and there were three of us outside investors.
Holly: Really?
Wally: In that meeting, yeah.
Holly: Wow.
Wally: So then I went for another 20, 30 years after that, and I think I bought the first Berkshire stock in ‘75 or ‘76 at about $300.00 a share.
Holly: Wow.
Wally: I’ve owned it continuously since then and my clients have been happy shareholders.
Holly: I’m sure. That’s everybody’s dream, right? [laughter] To have gone back in time and bought some Berkshire. Well, congratulations.
Wally: Well, actually, you know-- at the compound, I mean, it’s gone from $300.00 to $275,000.00, which is spectacular, but I haven’t recalculated it recently. But it’s around 20% a year compounded, and 20 doesn’t sound like much until you figure out what happens when you compound it for 44 years.
Holly: Sure. Certainly. And so now I wanted to get into your investing philosophy and what you’re doing. Well, you’ve been doing it for about 30 years. You opened your fund in ‘83, am I correct?
Wally: Yeah, I started the firm in ‘83. I started in the business in 1970.
Holly: It’s pushing 40 years, yeah.
Wally: Too many years to count.But yeah, we opened the firm in ‘83 and it was me and one clerical helper, and we started out with three private partnerships which have since been converted into mutual funds, and we got about 11 million in assets.
Holly: Gosh.
Wally: And it was basically a private client, high net worth individuals in the Omaha area that were the original clientele and we still have-- a pretty fair percentage of our assets has local ties.
Holly: Wow.
Wally: We had a 25th anniversary dinner several years ago and we invited all the clients who were original clients on June 1st of 1983 and that were still clients 25 years later.
Holly: Oh, my.
Wally: And we had about 80 people, had a nice dinner, it was a good old home week.
Holly: Wow. Yeah, a lot of people, I think, would like to have that kind of loyalty in their long-term. Long-term thinkers. So have you had the same philosophy of how you choose stocks and how you’re thinking about whenever you buy things?
Wally: Yeah, I mean, the philosophy’s always been the same. I hope I’ve learned to apply it better, and a good part of anybody’s learning process over a period of decades has to do with mistakes, and that happens in investing. But I think, hopefully we’ve learned from those mistakes, and so I’d say the portfolios in recent years have probably involved larger companies of higher quality, not necessarily debt-free, but I’ve learned to be much more conscious of a company’s capacity to service its debt, even under duress. So if you went back into the ‘80s and ‘90s and just looked at the kinds of business and the sizes and the quality, you’d see a fairly different looking portfolio, but the idea has always been the same, and that is that you’re buying a business. If you can buy it for a lot less than a private owner would pay for the whole company, then if the stock doesn’t go up by itself, you may very well find that a private buyer does come in and pay the full price for it. So you have multiple ways to win.
Holly: Yeah, win-win. So can you give us an example of maybe what was your favorite or your best investment that you’ve made? And maybe aside from Berkshire, unless Berkshire’s a great example.
Wally: Well, Berkshire is a great example, but another company, that’s actually a group of companies that I’ve invested in since probably the late ‘80s, and that would be-- originally the company was TCI, Tele-Communications, Inc. and it was the cable company that John Malone built. And over the years he’s collected programming assets and then he’s spun those out of TCI as Liberty Media and then he sold TCI to AT&T and ran Liberty. And Liberty has bought and sold various businesses, it now owns Sirius XM Radio (SIRI, Financial), it has a large investment in Charter Cable (CHTR, Financial), it owns Liberty Global (LBTYA, Financial), it’s a European cable company and it has a Latin American cable company, it owns the Atlanta Braves, you can go on and on with the assets. But over time he’s-- whereas Warren has turned a very small investment into a gigantic conglomerate all in one wrapper, being Berkshire Hathaway, Liberty has been willing to spin out a lot of their different businesses. So if you look in our portfolios today, you might find eight or 10 different companies that all have their roots in Liberty Media. So they have the common denominator of John Malone as the strategist and the keeper of the culture, but they’re in very different businesses with different managers and different financial structures. So even though they have common roots, from a risk point of view, they’re separate from each other. So if something were to go wrong, if Sirius or something were to go wrong, or the Braves-- well, maybe shouldn’t talk about the Braves. They’re having a bad season.
Holly: Okay.
Wally: But the value of the team keeps going up.
Holly: It stays, yeah.
Wally: Because wealthy individuals like their home baseball teams. But they’re separate. From a risk point of view, it’s as if it were loans that are not cross-collateralized, so some of our very favorite holdings are in that sort of family of companies.
Holly: I see. Yeah, I noticed Liberty pops up a lot on your top 10 holdings.
Wally: Yeah, and even ones that actually-- if you look at Liberty Broadband (LBRDA, Financial) or Liberty Ventures (LVNTA, Financial), both of those are really indirect. Well, they’re sort of closet ways to own Charter, but Charter is really the asset that matters to both of those.
Holly: I see.
Wally: Go ahead.
Holly: And you have a background in media stocks, is that correct? That you kind of specialize in that?
Wally: Yeah. It wasn’t intentional, necessarily, but back in the ‘70s, even, I would pay attention to what Buffet was doing and in those days he owned a lot of newspapers and TV stations.
Holly: Right.
Wally: And the idea behind those was that they had monopolies or near-monopolies on a service that people wanted and it had recurring revenue because of subscriptions. They required very little in capital investments, so that nearly all the profits were available as free cash flow. And over the decades, newspapers became a lot less good businesses.
Holly: Right. [laughter]
Wally: The internet made a big difference to all sorts of media companies. So the TV and newspapers gave way-- from the ‘70s into the ‘80s, it gave way to cable and both cable distribution, the ones who own the wires and now provide the broadband internet service and content companies that provided the programming. And that’s evolving now, as the internet makes it possible for people to get programming with streaming services. And they still have to have broadband, but they don’t have to necessarily subscribe to the video service. So there’s always changes going on, and that’s good from an investor’s point of view, because as it causes fears and consternation from time to time, people have a way of panicking and selling good assets at too cheap a price, and that’s what we’re looking for. The flip side of that is we have to make sure we understand that the changes are real and that we don’t end up-- you don’t want to end up today owning a newspaper company.
Holly: True. Yeah. Yeah, you answered my next question, which was about Netflix and how you’re handling that, but it seems like you’ve already thought through it and have it going solid. So I was going to ask you also about the concentration of your portfolio. The top 10 holdings represent maybe over half of it, and those are considered to be your best ideas, and right now the market, everyone knows, is hitting new highs, and how are you thinking about that mentally whenever your stocks may be crawling a little bit slower than the market? How are you thinking about that?
Wally: Yeah. Well, it’s interesting that the market’s hitting new highs and the majority of stocks, maybe, are very highly valued relative to what we think their business value is. So we’ve stayed away from some of the ones that have been the very strongest performers, just because we-- I think the odds, as something like a Netflix (NFLX), for example, it’s been a fabulous business success, but at today’s stock price, the risk-reward gets, I think gets shifted against the shareholder. And that doesn’t mean it can’t keep going up, but what we’re trying to do is buy things where the odds of success are really high. And the places we’ve invested with that in mind have been slower to rise over the last few years, so our performance has trailed the S&P and the main benchmarks, the absence of an Amazon and a Netflix has dampened performance. The other thing that’s held back our performance some is that we’re very willing to hold cash reserves, because when individual companies or the whole market get into a downdraft and people get nervous, it’s a wonderful thing to have cash reserves. And as it turns out, over the last six, seven years, there’s been barely a 10% correction a couple of times.
Holly: Right.
Wally: It’s sort of like owning fire insurance. We feel very comfortable owning it and it would really come in handy if there was a fire, but we haven’t had any stock market fires for so long that it’s turned out to be a-- the premiums, so to speak, have been costly. But this year our funds are up, I don’t know, 9, 10, 11, 12%, and it’s pretty much in line with the-- and the S&P may be up 12, 13, so if we can earn 8 or 10% without really having great successes, that’s a great consolation prize. When the cash comes in handy is times like ‘08 and ‘09 when even terrific companies can be down 60, 80%. And we were buying some of our-- some of the Liberty holdings that we have today are selling at 5, 10, 15 times what they were selling for at the bottom in ‘08 or ‘09. So, patience.
Holly: Patience, yeah.
Wally: Patience pays off. What’s unusual this time-- I mean, I’ve been through this for 40 something years, and there’s always periods of six months or a year or two years where we’re kind of out of step with the market because we think it’s too high, for example. But it usually ends much sooner than what we’ve had since the bottom in ‘09. So, it’s annoying, we’d love to have a lot more volatility and be able to find some bargains, but the last thing we want to do is chase the favorites as they peak out.
Holly: Right. Yeah, I think Howard Marks (Trades, Portfolio) talked about that in his recent memo, about how people who don’t sell whenever they meet their measure of intrinsic value because the stock continues to go up, he doesn’t understand, because when is the right time to sell, then, and look for the cheaper stocks? Should you wait two days after it starts to fall or four days after it starts to fall?
Wally: [laughter] Right.
Holly: I was wondering if that’s kind of what you think about that, as well, or do you have any comments on that statement?
Wally: Oh, yeah. I totally agree with that. I mean, I think Howard Marks (Trades, Portfolio), he’s a great writer and a great investor and his book, called The Most Important Thing, is I think one of the most accessible but really valuable investment books around. And assuming you can value the business accurately, I mean, it’s art, not science, but if something seems-- if a business seems to be worth about $100.00 a share and you can buy it at 50, then if you turn out to be wrong and it’s really only worth $79.00, you’ve still bought a bargain. But once it gets to 100 or 110, it can still go up some more, but the odds of you winning are just so stacked against you. Everything’s about probabilities. And if you, again, maybe not a good analogy, but the house, the casino has the odds in their favor, and somebody can come in and win a million dollar lottery or slot machine payoff, and the house loses on that ticket. But as long as they’ve sold enough tickets or there’s been enough chances taken, the odds will eventually revert to the house winning. And that’s the idea that Howard’s talking about, if you wait til the-- if you hold onto a stock as it goes higher or above its intrinsic value, if you do that enough times, you’re almost guaranteed to lose in the end.
Holly: Interesting. So going back to what you were saying a little bit earlier about selling and the market, and it seems like-- or in having cash reserves for whatever could happen, you mention that a lot. It sounds kind of ominous in your letters, that the raw materials are in place. You’re actually shorting the S&P, I believe, so I know you don’t want to talk about short-term movements, but what are you referring to? What kind of raw materials do you think are going to, could trigger volatility?
Wally: Yeah. Well, I think the basic underlying problem for stocks is their valuations, but they don’t go down just because they get over-valued. Usually it takes some sort of-- I mean, we’re dealing with people, again, not robots, so people are emotional and as long as they’re winning, they get to feeling smarter and smarter and more and more comfortable and keep buying more. But when I talk about the raw material to generate some fear, you can start with the headlines in the newspaper about North Korea, not to get off on a political rant.
Holly: I know. It’s hard.
Wally: But the current administration is probably over-qualified to generate scary headlines.
Holly: [laughter] Right.
Wally: But one of the reasons the market is so high and stocks are so expensive is that interest rates are so low, and the Federal Reserve has printed three and a half or four trillion dollars and bought bonds with those, which artificially depresses interest rates. And the same thing’s gone on with the Japanese Central Bank and the European Central Bank, and I think I’ve read that there’s somewhere in the 10, 12 trillion dollar range of quantitative easing that’s artificially depressed interest rates. Now the Fed has said-- I think they may have said today, they’re going to start with letting that four trillion dollar portfolio run off, and when they don’t re-invest the 10 billion or the 20 billion each month that’s maturing, somebody else has to buy those bonds, because the government’s still going to be running its deficits. And if interest rates are artificially low, you would think that at some point they will get back to normal, and it’s even possible that they could get above normal. Back in the late ‘70s, early ‘80s, the long-term treasury was 14%, now it’s 3. I’m not predicting it’s going to go back to 14, but if you own a bond, if you own a 10 year bond that yields 2% and the going rate for 10 year bonds goes to 3%, that bond’s going to go down about 8 or 10% and you’re going to lose four or five years worth of coupons in that price change. And at some point, people who’ve noticed that’s happening and they get afraid and they sell their bonds and maybe we overshoot on the other side. So higher interest rates, a return of inflation to more normal levels, when interest rates and inflation are higher, generally speaking, P/E ratios go down. So back in the early ‘80s, when rates were coming off that 14% peak, very high-quality consumer staples companies like General Foods and Nabisco were selling at six times earnings. Now that kind of company is low twenties, maybe higher twenties P/E ratio. So you don’t have to have a mortgage crisis and a great recession like we did in ‘08, ‘09 to have stock prices re-adjust to more normal levels.
Holly: Interesting.
Wally: I’m really not predicting the end of the world. I’m not predicting war with North Korea.
Holly: [laughter] Good.
Wally: I’m not predicting a recession. I mean, all those things can happen, but.
Holly: Right.
Wally: Look at companies like Visa (V) and Mastercard (MA), fabulous businesses growing at mid-teens growth rate in earnings, and we bought them when their multiples were between 15 and 20. And that seemed like high multiples at the time, but they’re great businesses. Now their multiples are in the upper 20s, and if a terrific business that ought to sell at, let’s say 21 times earnings is at 28 times today, and it just goes back to normal because of any number of factors and interest rates going up or whatever, a move from 28 times earning to 21 times earnings is a drop of 25%. Now, nothing bad happened to the company if it went down 25% because of the multiple, and next year’s earnings of 15 or 18% will cushion that, but it would take two or three years just to get it back where it started when the starting point is 28 times earnings.
Holly: I see.
Wally: It’s just a matter of-- if you pay too much for a-- it’s the Ben Graham staple. If you pay too much for a fabulous business, you’re speculating. And speculators don’t always lose, but the odds are against them, and so that’s why we like to hold some cash. And we only sell short in one of the funds, and that’s Partners III, and what we’ve done there is, our long positions are 90% of the value of the fund, but we’re short various stock indexes equal to about 30% so that our net exposure is about 60. And the idea there is that if we’ve picked those stocks well-- we own some Visa and some Mastercard and some Berkshire and so on, that maybe they’ll go down less than the index. So rather than just hold cash, we’ll buy a few-- we’ll buy more of our favorites and offset that with an index short.
Holly: Wow.
Wally: It’s not magic and we’re not trying to do market timing. Another reason I’ve done it in that fund is that we have a lot of unrealized gains in some of those stocks, like Berkshire and Visa and Mastercard, Liberties, and rather than sell them when they seem fully priced, pay taxes, and hope to buy it back cheaper later, and maybe failing at that, we hold onto it but sell something else that we think is just as vulnerable. And that’s where we end up with the short on the S&P or the Russell or something like that. The Partners III tends to have shareholders that are a little more tax sensitive than some of our other funds.
And so we do manage it with tax consequences in mind, we don’t want to let the tax tail wag the investment dog. But when one of our favorites goes down and gets cheap, we may double up on the position so that we can sell more expensive shares later and harvest the tax loss if we have one.
So there’s various tactics we use there that we do less of in the other funds.
Holly: Okay. Great. And in this market, do you think that any of the volatility that you’re looking for-- do you think any of it will be triggered by the headliners you mentioned? And why do you think that this market seems-- to me it seems impervious to these kind of things, like North Korea and politics and natural disasters and legislation that’s getting passed or not passed.
Wally: Yeah, and the environment, things are happening in the environment these days. Incoming inequality is causing some rumblings in the streets, there’s a lot of things going on, but as long as the interest rates are low and the market’s going up, I think there’s a lot of-- I think some investors just look at the interest rates and the benign. The economy’s not great, but it’s been moving forward.
Holly: Well, and global growth, as well.
Wally: Yeah. They look at benign conditions, low rates, and good momentum, and they think they’ll just ride it, as if they’re going to know the magic moment to get out. And I think others are very concerned and maybe bearish at heart, but they’re afraid to be out because either, as individuals they’ll miss out on something and their friends will do better than they do, or as professional investors, they feel like they need to be fully invested because if the market goes up without them, they’ll get fired. I remember, I was on the board of the [inaudible] Foundation a long time ago, and so I was the client and I was talking to a manager and he gave us this very bearish picture of the world. And I said, “Well, why don’t you own some cash-- why don’t you hold some cash if you’re so bearish?” And he said, “Oh, I’d love to hold cash,” he said, “But if the market goes down 20 and I’m fully invested and I go down 20%, I’ll keep the account, but if I have cash and the market goes up 20% and I’m only up 15, I’ll lose the account.” And I think there’s that career risk that keeps even bears fully invested at times like this, and that’s, I mean-- I can tell you, as somebody with cash and somebody that’s trailing the market by a few percentage points, it is uncomfortable and it’s annoying. But we just think it’s-- it’s the way we’ve-- we’ve beaten the S&P after-fees by about 200 basis points a year for the 30 some years, but that’s come in streaks, and I think it’s really happened because we’ve been disciplined about the price we pay and we’ve been willing to look a little dumb at times like these.
Holly: Have you seen a market like this before? I feel like I’ve heard the things that you’re saying whenever I’ve been reading about more historical markets. So is this parallel to anything?
Wally: Yeah. Well, like I said before, there have been times like this all through the decades, but they usually didn’t last longer than six or 12 months, or maybe a year and a half or two. But in the late ‘90s, when the tech bubble was inflating, we actually kept up with the market pretty well because we had a lot of cable companies and they were-- I didn’t think of them as tech stocks, I thought we were outside the tech bubble and we just owned good subscription businesses that were growing. But it turns out that a lot of people were buying them as internet providers and so we happened to keep up with the market in that ‘97, 8, 9 timeframe, but there was a lot of value investors who were trailing very badly because they were sticking to their guns and what they were doing did not allow for paying $500 billion for Sysco at the time. So that was one of the most parallel.
Holly: Okay. Wow.
Wally: If you get into ‘05, 6, 7 with the mortgage buildup and the housing boom, I think that was another time when I think many people recognized that there was an overheated housing market, an overheated mortgage market, but they didn’t really dare not play the game. I think it’s a common phenomenon, that this time it’s gone on for seven or eight years and it’s just gotten kind of ridiculous, yeah.
Holly: Yeah, interesting. I’m running low on time, so I’m going to just quickly ask you one more, before we move on. And what do you think is cheap right now?
Wally: Nothing.
Holly: Nothing? [laughter] That’s what I thought.
Wally: Yeah. Having said that, there’s a few things that are less expensive, that we’re happy to own in a market like this, and I mentioned Charter earlier. Charter is a cable company that just bought Time Warner Cable and Bright House, and it’s in the process of integrating those companies, and the stock has been weak the last few days because cable and media stocks in general have been weak. So it sells at $367.00 a share, we think it’s worth something a little over 400 in today’s world. We’re using a discount, we think it’s worth 500, say, three or four years out. We discount that back and call it 4, 420, something like that. So Charter’s maybe a 10% discount, 15% discount to today’s value. The value is growing, and then we can buy an interest in Charter indirectly by buying Liberty Broadband and Liberty Ventures. And we think that broadband is at an additional 15% discount to Charter, because people don’t understand it, and Ventures is probably another 5 or 10% cheaper than broadband. So by the time you go through those layers, we’re having something like 65, .70 cent, a dollar, which is not fabulous, but I think it’s going to pay us very well over the next three or four years. If the market goes down 25% in the interim, everything will go down together, but the value is there, and that’s pretty interesting, I think.
Holly: Great. Thank you for that. We promised that we would get to a couple of reader questions, if that’s okay with you?
Wally: Okay.
Holly: So these are ones that were submitted by people that read GuruFocus, so thank you for your questions. And so the first one is, besides Warren Buffett (Trades, Portfolio) and John Malone, who is your favorite management team and why?
Wally: There’s a lot of good managers out there. I think in the cable world, Brian Roberts at Comcast is really terrific. He’s second generation and very intent on covering the downside, because it’s the family business, but also very creative and aggressive at the right time about making bold moves. Some people may remember, he tried to take over Disney years ago and when the financial crisis came along, he was able to make a terrific deal with General Electric, who was in some distress, to get a cheap buy on NBCUniversal, so I think he’s a very good version. Tom Rutledge at Charter is a great operator and for the project of consolidating Charter and turning it into maybe a Comcast in the future, I think he’s another candidate. Somebody like Jeff Bezos is a fabulous business person in the sense of winning in the markets in which he’s competing. My only quarrel with Amazon (AMZN) is not that it’s taking over the world, it’s just that if the competitors are losing 100 units of value, 60 or 80 or 90 of those units of value are going to the consumer, not necessarily to Amazon. So at some point he’ll need to cash in, but he’s fabulous as a strategist and for being bold.
Holly: Yeah. He’s done an incredible thing, that’s for sure, Amazon. I just ordered things on there again, like I do all the time. It’s a company that everyone uses frequently. And so how do you determine whether a company can improve margins through cost cutting without foregoing new business opportunities or hurting the underlying business?
Wally: Well, I think that’s art, not science. I think if you-- you really need to understand what makes the business work, and what the key variables are, and if one of those key variables is, for example, customer service or the customer experience and you see a company cutting costs and impairing that experience, you can guess that they’re headed for trouble. On the other hand, if you-- I’m trying to think of a concrete example, but there’s a lot of cases where a very good operator, let’s say a Danaher or a Colfax, which are very good manufacturers and operate very lean businesses, sometimes can make acquisitions of companies that are a little chunkier, a little fudgy in their cost structure, and then they can do cost cutting there and have it actually improve the business. I guess maybe the classic example is 3G taking over Anheuser-Busch, and Heinz, and Kraft, and making very dramatic cuts in the cost structures. There’s a book about them taking over Anheuser-Busch and the experience of the Busch employees in St. Louis, and not only losing their airplanes, but maybe losing their desks and having to share a telephone, losing their country club memberships. And that’s cost cutting.
Holly: Extreme.
Wally: Up to a point that can really improve results, but you don’t want to mess with how the customer perceives the business or the quality of the product or that sort of thing. It’s a case by case situation.
Holly: Okay. Interesting. And somebody wants to know why you sold Apple (AAPL), but from what I understand, you didn’t sell Apple. Maybe someone at your company did. So are you familiar with that person’s thinking on why they sold Apple?
Wally: Well, I think one of our analysts has done a very good job of following Apple and recommending it. And we did buy it and one of the other funds that I don’t manage, and had a terrific experience with it, so it was my mistake to not buy it. I think the sale is just a matter of valuation, there’s nothing negative that’s new or different about Apple. It’s just a matter of we were buying it at, I think, under 10 times earnings, and it’s had a-- it’s probably up 50, 60% from there. And again, it’s just evaluation and a matter of odds. It could well be that we would own it again.
Holly: Okay. Okay, we have another one that’s a little more complex, but I think it’s interesting. So the reader says, “How do stock buybacks affect stock prices? From the academic point of view, they do not. However, in reality it seems to act in the opposite way. When there is a buyback of a large magnitude, most of the time the stock goes up. Even though there are exceptions, stocks going down after a stock buyback announcement is relatively rare. Could you give your thoughts on this? Thank you.”
Wally: Okay, well it is, yeah-- there are many facets to that. There are a lot of announcements, especially at times like the Great Recession where companies will announce a buyback and then not do it, which obviously the impact there is psychological and temporary. But I think the thing to be careful with on stock buybacks is that it’s like so many different things. Buying back stock is one of the three or four main choices that a company has of what to do with their excess cash, or with borrowed money, and they can make acquisitions. They can buy back stock, they can pay dividends, and a buyback of shares can be a terrific thing to increase the per share value of the stock or of the company, if they’re buying it at a cheap enough price. So if the business is worth $100.00 a share and they can buy shares in at 50 or $60.00 a share, that’s likely to increase the per share intrinsic value of the remaining shares, and it’s a great thing. Shareholders can have a choice, they can either participate and sell stock back to the company or hold on and have the more valuable shares. On the other hand, and historically what has happened more often than not, is that companies are feeling flush and strong and in a buying mood as their stock goes up, and they end up paying too high a price for it. And if the stock is worth $100.00 a share and you pay 150, if the company buys shares at 150, it’s deluding the remaining shareholders, it’s a bad thing. So it’s all about-- there’s a lot of buybacks going on now at record high prices using borrowed money, because they can borrow at a 2 or 3 or 4%, and they’re overpaying for the stock and diluting the equity value and creating a future liability where they have to pay back the borrowed money. So it can be-- I have a friend at Capital Group, we have a lively debate when we get together every summer about whether buybacks are good or bad and the truth is, it depends. It’s like so many things in the world. Everybody wants a black or white answer so that they can immediately react to a piece of news, but it’s always more complicated than that. Warren Buffett (Trades, Portfolio) has gotten very specific over the years in his letters. I think interested readers of your publication probably read Warren’s investor letters, but it doesn’t hurt to go back and re-read the annual letter. And he’s talked over the years about when buybacks are good and when they’re bad. He’s talked about Berkshire Hathaway more and more specifically the last three or four years and how he figures intrinsic value and why he thinks that the growth and stated book value-- which is just an accounting convention, the book value grossly understates the intrinsic value of Berkshire, but that the book value growth parallels the growth and intrinsic value. So what he has said is that if he can buy stock back at book or even up to 1.2 times book, he’d be happy to do that because he thinks that would increase the intrinsic value per share of the remaining shares. He’s also said that if the stock were selling at, say, two times book, that an individual investor buying stock at that price might have dead money for several years, and he would never want to buy it back for the company at twice book. You can graph it with Berkshire, you can plot the growth in book value, which is maybe 8 to 10% a year on average now, it used to be in the 20s. And now there’s no guarantee that at 1.2 times, he’s going to put a floor under it, but if he’s willing to buy it at 1.2, you might want to think of-- something in the 1.2 to 1.3 range as being sort of in line with his thinking of a cheap price. But again, never go for the simple answer. And I think that’s something that Howard Marks (Trades, Portfolio), in that-- he calls it The Most Important Thing, but what it really is is 20 chapters and each one of them is the most, the 20 most important things.
Holly: The Most Important Things. [laughter]
Wally: Yeah. I think he probably covers stock buybacks in there. I don’t remember for sure, but you might refer your reader to that book.
Holly: Okay. I’m sure he’ll be picking that up now, he’s got [inaudible] information there.
Wally: [laughter] Maybe I can get a royalty from Howard.
Holly: Yeah, a recommendation, or endorsement. So we kind of know the answer to this one, but we wanted to get your thoughts anyway. What do you think about cigar butt investing? And for people who don’t know, that’s where you buy a dying business for its last puff of air. And a lot of people have done this that are famous, Warren Buffett (Trades, Portfolio), Walter Schloss, Seth Klarman (Trades, Portfolio). So what is your view on the cigar butt investing method?
Wally: Yeah. Well, Warren writes a lot about that, too. Cigar butt is his term for what Ben Graham really started with back in the ‘20s and ‘30s. The idea was that if you could pay a stock price that was less than the working capital per share of that business, that you would never lose money. And as far as it goes, you’re likely to get a positive return if you do it enough. It’s like the idea of the casino. If the odds are in your favor and you do it enough times, you’ll come out with a positive return. But what Warren credits Charlie Munger (Trades, Portfolio) for doing is enlightening him about the fact that it’s much more lucrative and likely to be much more profitable to buy a good business at a fair price, and he always used the example of See’s Candies. But cigar butt investing is sort of like if you used your putter all the way around a golf course. You’d never go out of bounds and you’d eventually get the ball in the hole, but you’re not likely to score very well.
Holly: Right. Okay, well, finally. We’ve taken up quite a bit of your time, and wow, thank you. It’s been almost an hour. You already mentioned a couple of books, but we want to know your top three book recommendations or maybe just one really good one.
Wally: Well, Ben Graham’s Security Analysis is the textbook and it’s the greatest. It’s heavy going, but everybody ought to make themselves read that, that’s the vegetables part, I guess, maybe. But the Howard Marks (Trades, Portfolio) book, The Greatest Thing or The Most Important Thing is a great one. There’s another book by a private equity investor named Thorndike called The Outsiders, and it’s a chapter on each of, six, eight, nine great managers of businesses over the years, and “outsider” sort of referring to the fact that they manage the company in an unconventional way, and they were great with capital allocations. So it talks about Henry Singleton, who had a grossly over-priced stock back in the conglomerate heydays in the ‘60s and used the stock to buy dozens of companies, and then when the stock was cheap in the ‘70s, he bought it all back at pennies on the dollar, and it was a fabulous experience for investors. And he also talks about Warren Buffett (Trades, Portfolio) in there, and he has a chapter on John Malone. Just great stories of the kinds of businesses that I think your readers ought to want to invest in, assuming they can get it at the right price. So that’s one of my favorites. There’s another one that just came out, I’ve only read half of it, but I know the author, Joel Tillinghast.
Holly: Oh, yes. He’s going to be on the next episode.
Wally: Oh, is that right? Okay.
Holly: Yeah. That’s really funny.
Wally: Well, tell him I recommended his book.
Holly: Yeah. Another great ending note.
Wally: Yeah. It’s called Big Money Thinks Small, and he’s a very interesting guy, he’s just-- I think he has a 30 or $40 billion fund, and has 800 or 1,000 stocks in it and he knows them all very well. So it does take a lot of work, but the book, at least as far as I’ve gotten, it’s a different version of the Howard Marks (Trades, Portfolio) book in that it’s trying to coach investors on how to think about what they’re doing. Think about where they’re looking for investments, how they’re interpreting what they see in the reports, how to avoid psychological pitfalls. It’s a good one.
Holly: Okay, well, good.
Wally: Unless it gets bad in the second half. I can’t promise it won’t, but I think it might be a good one.
Holly: Okay. Great, well, once again, we’ve been here with Wally Weitz. He’s the head of Weitz Investment Management, a $4 billion firm in Omaha, and he’s one of the great minds in value vesting, so we’re really appreciative of the conversation. Thank you and have a good day, Wally.
Wally: Okay. Thank you.
Holly: Bye.
Wally: Bye.
