Friday, March 27, 2015

The Last Thing I Would Want to Do

Best case scenario is when you can find something you want to do. But you can learn a lot by simply ruling out things you do not want to do as well.

This week's WSJ reported on money managers who spend a tremendous amount of time worrying about the market hour by hour.

"Most mornings at 5:45, David Kotok hops on his exercise bike, straps a small miner’s lamp to his forehead to read in the twilight and begins scouring research reports for signs the stock market could crumble.

The Florida money manager, who is 72 years old, is bullish, but things can change suddenly. This month, he moved heavily to cash amid signs of trouble, but soon returned to stocks. So he pedals onward, reading reports and shifting two smartphones and a sheaf of papers to avoid drops of sweat.

In Minneapolis, Doug Ramsey ’s daily ritual involves tracking 130 indicators on subjects from corporate performance to investor mood. He isn’t as bullish and has reduced his stockholdings.

“I think about it hourly. It really keeps me up,” said Mr. Ramsey, chief investment officer at Leuthold Group, which oversees $1.6 billion."

Ok first off, I am sure that they are smart and have lots of money, but what a way to spend a life - predicting markets? Darting in and out based on 130 different indicators? 

I find Tom Gayner's "nobody knows nothing" and Howard Marks' "you can't predict but you can prepare" approaches both more successful and a far better quality of life.

As opposed to worrying about the hourly movements of 130 different indicators, instead of that what about Charlie Munger - "I succeeded because I have a long attention span." 

Beyond quality of life, I think it pays dividends towards long run returns to approach things that way. Investing skills can increase with age. Buffett's Heinz deal appears to have been one of his best, and that is saying something - Get paid 9% dividend for two years during which time you triple your money on a low risk investment.

Hard to top that. Not everyone is Buffett you say, not everyone can partner with 3G. All true. But even outside, individual Kraft investors have doubled their money, got paid a healthy 4ish% dividend, and now are part owners in a business that includes Heinz and is run by one of the best operators on the planet. 

By contrast of the 130 hourly indicators, here is the grand total of all time I spent worrying about Ketchup and Mac and Cheese consumption, wait I will round it down to the nearest whole number - zero!

On the plus side, the WSJ piece produced a modern day rarity - smart comments on an online  newspaper article.

Paul Wm Danielsen 2 days ago
Big Index Funds
Call me when I'm 70
( a miner's helmet light. Really ?!? )

Karen ThomasKaren Thomas 3 days ago
I've long believed one must view the circus from the outside and then make  decisions. In other words, watch the clowns to determine what to do.  There is much to learn from watching the show. It's insightful  to read the machinations of such managers.

Much in our culture (and others)  promotes short-term thinking. Perhaps our perceived enhanced degree of impatience and the promise for quick rewards is a by-product of technology and of course other things.  However, this mind-set has long been a part of societies. The media and it's advertisers (which is the media) pushes much of this. The cynic could say we are awash with snake oil sales people and their "idea of the day". These same people usually always have a vested interest in these ideas. Don't take them too seriously because they will have a new idea tomorrow along with another bottle of oil. There's a reason snake oil stands are in close proximity to a circus.

Wednesday, March 25, 2015

On Predictions

from Tom Gayner in the Markel annual report:

"A second example of how markets periodically become unhinged from long-term reality can be seen in the current action of the oil market. Arguably, oil is the most liquid, important and globally traded commodity on the face of the earth. Hundreds if not thousands of companies participate in the energy business. Hundreds of thousands if not millions of people work in, and study this field. The fact that oil could sell for over $100 per barrel, and for less than half that price within a few short months, should be about all of the evidence you need to dismiss those who believe in efficient markets, or forecasting just about anything.

Our investment record has not and will not be based on our ability to forecast the future of geopolitical changes, interest rates, currency moves, technological change or any other factor that occupies the minds and hours of countless investment professionals. We simply accept that all of those things will continue to fluctuate and change, and that our four part process does the best job we know of finding the people and financial circumstances who will make the best of whatever happens."

Here is my version. Four years ago, Kraft split apart into two companies. The high flying, international, big name brands went with the CEO and became a new company - Mondelez. The boring US-only, low/no growth businesses like Mac and Cheese, Oscar Mayer, and Planters became their own company still called Kraft. Naturally I liked the latter one, which had an excellent dividend policy. I liked it as a 10-20 year hold with a chance to slowly compound over a long time horizon. Needless to say I liked the company's long term prospects, but never thought it would go up 33% in a single day.

If I made a list of stocks that I would wake up and see a hockey stick on, Kraft would be very close to the end of the list. Which begs the question, if we cannot reliably predict the Mac and Cheese and Ketchup market, what chance do we have on oil and energy? As Howard Marks says, "we can't predict, but we can prepare."

Monday, March 23, 2015

Markel Annual Letter

The motto of this blog is Safety, Dividends, and Growth, but the overall goal is total return. Safety is a hard and fast rule, and generally dividends are excellent path to total return. But there are exceptions. One is Berkshire Hathaway which offers an excellent profile - about the safest company with exceptional long run returns. So while dividends are a main focus, there is no need to be dogmatic when it comes to a company like Berkshire.

One other exception to the dividends rule is Markel, sometimes called a "baby Berkshire." Like Berkshire, Markel is ostensibly an insurance company in Markel's case a specialty insurance company (see Tom Gayner's cocktail party summary of Markel's business model below(1)).

Like Berkshire, Markel has a three legged stool. Markel generates cash with its core insurance business.

Combined ratio

  • 2010 97%
  • 2011 102%
  • 2012 97%
  • 2013 97%
  • 2014 95%

So Markel has been able to turn a profit on its insurance operations four of last five years.

Next, the second leg of the stool - equities. Like Berkshire Markel chooses to invest a lot more in equities than bonds as most insurers do. Markel CIO Tom Gayner turned in another solid year with 18.6% gains in equities in 2014.


  • 2010 20.8%
  • 2011 3.8%
  • 2012 19.6%
  • 2013 33.3%
  • 2014 18.6%

That amounts to a weighted average 5 yr annual return: 20.4%. Markel completed the acquisition of Alterra, another insurance company whose portfolio is largely in bonds. Given that Markel's five average return from fixed maturities was 4.7%, there is a significant opportunity to convert bond holdings to equities and earn at least double what the bonds do.

The equity portfolio, like Berkshire's, is low turnover and high quality. Top holdings:

  • CarMax - 8.7% of portfolio
  • Berkshire Hathaway - 5.99%
  • Brookfield Asset Management - 4.4%
  • Walgreens - 4.3%
  • Fairfax Financial - 3.9%
  • Walt Disney - 3.8%
  • Diageo - 3.7% 

These first two elements - profitable underwriting and investing - have propelled Markel throughout the last twenty years or so. But there is a third leg of the stool to Berkshire's model - wholly owned businesses. Berkshire now owns many more businesses than it has invested in equities.

Markel is not large enough today to buy up huge companies like Burlington Northern, but they have proven to be quick learners and fast followers in recognizing the efficiency of buying whole companies.

In 2005, Markel started Markel Ventures to buy up whole companies. Like Berkshire, they tend to be on the dowdy, but profitable side. Channel dredging, bakery, waffle maker manufacturers and the like. This third leg of the stool is the one I have been watching for to propel Markel to the next level, and it appears it is starting to:

"From the start in 2005 when we purchased 80% of AMF with its roughly $60 million in revenue, Markel Ventures ended 2014 with revenues of $838.1 million and Adjusted EBITDA of $95.1 million. Markel Ventures now stands as a real, and meaningful contributor to the wealth creation underway at Markel Corporation.

Markel Ventures does two things for Markel. One, it gives us another option for capital allocation decisions. Secondly, it makes a bunch of money. As one frame of reference for that statement, consider Markel Corporation 10 short years ago. In 2004, we earned underwriting premiums of just over $2 billion and underwriting profits of $72 million. While the language used to describe underwriting profits from insurance operations, and cash flows from non-financial businesses, are different, it’s not that hard to translate. Underwriting earnings are generally comparable to Earnings Before Interest Expense, Taxes, Depreciation, and Amortization. They equal the acronym EBITDA. In 2014, the Adjusted EBITDA of Markel Ventures, which also excludes a non-cash goodwill impairment charge of $13.7 million, totaled $95.1 million. This stuff is starting to add up."

Put it all together and Markel has established a good position in each of the Berkshire three legged stool. It has profitable insurance operations, a solid equity investment track record, and now a burgeoning wholly owned group of businesses. So Markel has all three legs of the stool in place and effective.

One question I have for Markel is that Tom Gayner is the face of the investment operation, but what is the bench? Is there a Munger, Simpson, Weschler, Combs at Markel?

Overall, the company has proven its ability to learn from a great example and implement as close as anyone else has - The Berkshire Operating system


1. Markel CIO Tom Gayner (circa 2011):
"Cocktail party definition of Markel if someone asks about Markel, its an insurance company that they've never heard of. Well an easy way to think about that is if you have an insurance policy that you can get easily and quickly, well we wouldn't do that. We do the sorts of insurance where people go 'Oh no. We've got a problem or we've got a situation' This isn't to disparage the other insurance companies, we all have a role in life. What GEICO says yes to is not going to be the same thing that Markel says yes to. What Markel says yes to isn't going to be the same thing that GEICO says yes to. Its a different organization and orientation.

We do 100 different forms of insurance - everything from children's summer camps that are out in the middle of nowhere, that have teenagers supervising teenagers and no fire departments nearby, kids jumping on trampolines and being out in canoes, all the sorts of exposures that go with that.

We would do oil rigs that are out in the Gulf of Mexico (one of the ways we lost some money this year), those sorts of things need insurance and Markel is a company that for decades has been in that business, and its a good business, but there are days when you wake up and read the headlines and go 'Oh no', but that is why people buy insurance.

We do things like bass boats with too big a motor on it, this has always been intriguing to me. Bass boats tend to be flat bottomed, and they come with a 10-15 hp motor or something like that, but if you are really into bass fishing you have to get to the spot in the corner of the lake faster than the other guy. So people put 250 hp engines on their bass boats. I can tell you that every accident or loss report reads the same way, and that is: 'Craft traveling at a high rate of speed, when it hit a submerged object. Occupants hurled from the craft.' When you are trying to buy insurance on your bass boat and you are a State Farm or  GEICO customer, they're going to ask you about how many horsepower you have on your boat and when you answer 250 they're gonna say 'thanks but you need to find somebody else to that.' 

Well, we're the Statue of Liberty, bring us your tired your poor, yearning to be free. Short line railroads, little spur lines with only one customers. We do bars and taverns that are sometimes on the wrong side of town. On and on and on.

Thursday, March 12, 2015

Cloning Woodford

Cloning is a great American tradition. Specifically, there's a long history of Americans successfully cloning British ideas, think about "The Office." Who was better David Brent or Michael Scott? Who cares, they were both great. In that spirit let's take it to stocks, and cloning ideas from great investors, done right, is a solid strategy.

Neil Woodford manages stock market thumping Equity Income funds for several decades. Todd Wenning points out that Woodford's distinctive style and excellent results can be traced back to a focus on dividend growth.

Its interesting to follow Woodford's portfolio for both individual selections and for what areas he avoids. For a fund that dwells in the Equity Income segment, he has long eschewed some traditional dividend paying sectors like energy and banks.

Woodford's main stock picks naturally are heavily slanted to the UK, but I wondered if he worked in the US, what stocks would he buy?

So I put together a list of Woodford's top ten holdings and then looked for a rough US equivalent.

One note is that the current S&P 500 yield is 1.9% whereas the FTSE 100 yields 3.2% Woodford's Equity Income fund has a goal to achieve a 4% yield. To do 4% today in the US means a pretty limited pool - utilities (and many of those are less than 4%), MLPs, and some distressed stocks. So for our "US" version of Neil Woodford portfolio I will use a range around 2.5% instead of 4% to account for the lower base of the overall US market.

The most challenging parts of cloning Woodford's approach for a US investor is right at the top. Woodford has positioned for a slow/low/no growth world with a lot of healthcare. Three of his top ten and two of the top three are big pharmas that pay excellent dividends - AstraZeneca, GlaxoSmithKline, and Roche. That group averages a 4.4% yield,  hard to come by these days from anywhere much less excellent, wide moat companies like these.  The best US proxies I can think of are JNJ, Merck, and Baxter. These companies can deliver a lot of quality, but they cannot deliver the same yield as Woodford's bunch, they only amount to a 3% average yield.

Next up, Consumer, which in Woodford's portfolio means tobacco. Three big international tobacco companies - Imperial Tobacco, British American Tobacco and Reynolds American for an average yield of 4.2%. We can draft Reynolds onto US Woodford plus add Altria and Phillip Morris, and we get a 4.2% yield as well. Given that the US market offers lower yields, the tie goes to US Woodford.

Woodford added BT after a spell of not owning much in the way of Telcos (another traditional dividend haven). Here the US Woodford is in a good position Verizon yields more than BT.

For industrials, Woodford holds Capita and BAE, defense and utilities have long been stalwarts in his holdings. The average yield here is 3.3%. Unlike pharma, this is a fairly fertile area in the US for dividend seekers, I did not have trouble finding quality companies with solid yields, and I could have gone into pipelines, REITs and other sectors, but sticking with the same kind of construction - Southern Company, GE, and Lockheed combine for an average 3.7% yield.

Sector Woodford US Woodford
Pharma AstraZeneca (4.2% yld)
GSK (5.6%)
Roche (3.3%)
Johnson & Johnson (2.8%)
Merck (3.1%)
Baxter (3.1%)
Consumer Imperial Tobacco (4.5%)
British American Tobacco (4.4%)
Reynolds American (3.8%)
Altria (3.8%)
Reynolds American (3.8%)
Phillip Morris (4.9%)
Telco BT (2.7%) Verizon (4.4%)
Industrials Capita (2.5%)
BAE (4%)
Southern Company (4.7%)
GE (3.5%)
Lockheed Martin (2.9%)

Overall, Woodford's fundamental approach to both stock selection and stock sectors to avoid (energy, financials, tech) looks to travel across the Atlantic very well. Outside of pharma there are rough US equivalents that deliver similar and in some cases arguably better characteristics. Hybrids are the strongest plants in nature, why not plant a British tree or two in the US. What do you think of the selections? Which ones would you choose to make a US Woodford clone?

Tuesday, March 3, 2015

What Matters in The Long Run

Here is a guest post from my friend Adrian Lane that shows what long term time horizons can do, how they massively overweight any other single advantage, and a lesson on when to sell:

"In the 1990s, working in tech during the great Internet surge, cash flow was good. My wife and I decided to begin investing some of the extra money we earned at the end of each quarter. We started with small sums of $500 here, $1000 there. 

In 1997 we bought a handful of shares in Home Depot (HD). We purchased shares just after the 1997 split so, which means we saw the stock split in 1998, and again in 1999, rolling the small number of shares into a larger number. When the tech collapse occurred, we stopped investing, and pretty much forgot about those investments, knowing full well one or two had failed outright. 

Now that we have 18 years under our belt, it’s fun to look back and see where we are, and HD is one of the highlights. Price adjusted for the two subsequent splits - our original investment was about $11/share. At the moment I am writing this HD is trading for $116/share price, with a 1.67% yield. My yield on cost - meaning yield compared to what I paid originally, is ~ 52%. HD announced a significant dividend hike for the next round of payouts on March 26, 2015. My new yield on cost will be ~61%!  That’s what 18 years and a quality stock will get you. 

My friend Gunnar said: 'Great story. Great illustration of massive power of time and quality. '

To which I said yes, but there is a more important lesson I have learned from this. 

When the stock hit 76 a share I thought it had run it’s course. Told my wife I was going to sell it. When looking at the fundamentals of the business on paper it looked like it had run out of steam and was due for a long period of inactivity. How on earth with new construction slowed and baby boomers not able to update their homes is HD going to continue to defy gravity? She said ‘No’. This was about the time I read the Buffett’s answer to the question “Ideally, how long do you hold a stock” - “Indefinitely”. So I agreed with her.  

At first I thought I was right as it muddled between $74 and $82/share for 18 months. Then it shot forward again. Now it’s doubled in value if you consider stock price and dividend combined. It’s still the same quality business it has always been and it continues to grow. At this rate,  before the end of this decade, it will pay me back my original investment in dividend every year. 

So my lesson was "If there is nothing fundamentally wrong with the business, DON”T FREAKING SELL IT".

I don't have much to add, this post says it all very well, but the one thing I would say is that one reason that I find quality income investing so effective is that even at the end of this terrific performance by Home Depot - it's still worth holding, the business is as strong as ever. If you compare that to a growth stock where you get it right, you then have to sell and find another good one. You have to be right twice (or more). With a quality income stock, you only need to be right once and then let the company do the work.