I have missed this book, until now. Seems it is highly negative one form an author with a penchant for short term investing.
I wont be reading it, but here it is.
Darren, Everything Warren Buffett.
March 09, 2009 | about stocks: BRK.A / BRK.B
A review of Vahan Janjigian's book, Even Buffett Isn't Perfect: What You Can-- and Can't-- Learn from the World's Greatest Investor:
Chapter 1:
The chapter starts with two seemingly contradictory quotes from Buffett. In one he asserts that his company does not follow standard diversification dogma, and in the other he suggests that 99 percent of investors should diversify extensively.
The chapter goes on to discuss that these statements are not in fact contradictory. Diversification is used to reduce risk for investors who have neither the time nor the inclination to study the companies they are buying. In Buffett's case, he knows his companies (and their industries) well. As such, he reduces his risk in this regard, and therefore does not require as much diversification.
The chapter continues by discussing some of the finance theory regarding diversification, defining and explaining terms such as variance, correlation and standard deviation. It then discusses why Warren Buffett is not a big fan of this theory: It is impossible to know the above parameters with certainty. For example, you might think airlines and oil prices have a certain negative correlation, but in a market panic you can basically throw that correlation out the window.
The chapter also discusses Berkshire's apparent move to diversify over the years. However, the conclusion of the author appears to be that as Berkshire has increased in size, it has had no choice but to do so. It is very difficult to find amazing deals in the tens of billion dollar ranges since the population size of this group is so low. Nevertheless, the majority of Berkshire's investments are concentrated in only a few companies, meaning Buffett is not as diversified as finance theory would suggest.
Chapter 2:
In this chapter, the author discusses the finance industry's tendency to label fund managers as either growth or value. Value stocks tend to have low P/E and P/B ratios, while growth stocks can be said to be in favour due to their high P/E and P/B values. But Janjigian disputes that such a distinction can be made in the case of Buffett. Although most of Buffett's purchases would fall in the value category, he will buy companies that appear expensive but exhibit tremendous growth.
To illustrate the difference between growth and value, the author takes the reader through an investment in the Washington Post versus an investment in Google. It is clear from the data that Google is the more expensive stock (higher P/E, P/CF, P/B and P/S), but the difference is explained by the appeal of Google's growth potential.
Where Buffett sees an issue with the way the finance industry treats growth is that expectations get out of hand. Investors almost always pay too much for growth, as expectations are rarely matched by the actual results over the long term. The author also discusses the fact that growth always invariably slows down, even for the best companies.
Indeed, despite the fact that Buffett would probably agree that Google is a fantastic company, he would still rather own (and does) The Washington Post than Google, as the author argues it's the price of the stock relative to the value of the firm that counts, not simply how great the firm's prospects are.
The author concludes the chapter by discussing how Buffett determines whether a company is cheap: The discounted cash flow valuation. To Buffett (and indeed most of the finance world), an investment is worth the discounted future stream of cash flows that accrue to the investor. This estimate of the value of a company can fluctuate wildly with tiny changes in assumptions. This is why Buffett prefers companies that are easy to understand, as the future cash flows can be predicted with more certainty.
Chapter 3
In this chapter, the author discusses some of the academic research devoted to studying the performance of value versus growth stocks. As defined earlier, value stocks are said to be those with the lowest P/E and P/B values, while growth stocks are those at the opposite end of the spectrum.
The author concludes that value stocks do outperform growth stocks over time, citing and discussing several studies. It is worth noting that value stocks do not outperform in all periods, however, the longer an investor sticks to value investing, the more likely he is to outperform the market.
Within the value stocks, the author determines that the small-cap subset outperforms the most. Buffett clearly agrees, as he has stated many times that as Berkshire gets larger, he cannot possibly match the returns he was able to achieve back when he was starting out.
Though Buffett and many value investors tend to buy and hold, the author does argue that traders do provide a valuable service. They offer liquidity to the market which would not otherwise be present, thus lowering trading costs (lower bid ask spreads, more scale for brokers etc) for all investors. It is also noted that traders prefer growth stocks since these are the stocks that perform well for momentum investing. Academic research cites that momentum investing can be used successfully.
Chapter 4
The moral of this chapter is: "Never Marry A Stock".
The author points out a number of instances where some of Buffett's stocks may have traded above intrinsic value, but Buffett has not sold. Unfortunately, this costs his shareholders money. The author argues that Buffett doesn't do this because he doesn't want to maximize shareholder value, but instead this is a result of the fact that Buffett does not think of himself as a stock picker, but instead a buyer of a business. As such, Buffett marries businesses.
The following quote from Buffett in Berkshire's Owner's Manual illustrates this point perfectly:
"You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns...[G]in rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior."
Janjigian also discusses one method of investing that Berkshire is able to do that ordinary investors cannot: Private Investments in Public Equity (PIPE). Large investments in public companies allow the public company to save time and money. Some of this discount can be passed onto the buyer, who gets a deal on a stock that ordinary investors cannot. The author discusses a number of such PIPE deals Berkshire has profited from.
Chapter 5
In this chapter, Janjigian discusses some further criteria Buffett considers before buying a company. It is stressed that Buffett puts a tremendous amount of weight on the quality of management. He has often spoken about the importance of good managers.
The author examines the details (that are public) of various purchases Buffett has made over the years, including those of Forest River, Business Wire, Iscar Metal, PacifiCorp, and Russell Corp.
Buffett's approach to finding investments is also explored. The author says he does not go looking for companies, instead preferring to wait for the right opportunity to come to him. He is certainly not afraid to hold cash, unlike most of the trigger happy portfolio managers littering the finance industry.
Although Buffett is known as a buy and hold investor, Janjigian points out many instances where a stock has remained in Berkshire's portfolio for only a short period of time. Examples of such companies include Best Buy (BBY), Gap (GPS), and PetroChina (PTR).
Chapter 6
While Buffett has undoubtedly successfully purchased many companies at discounts to their intrinsic values, he is only human. This chapter is dedicated to describing some of the investment mistakes Buffett has made.
First of all, it is actually difficult to determine when a Buffett investment has gone wrong. Unlike the case with short-term trading, value investments can sometimes take years to show their expected returns. Many of the companies Buffett has purchased have actually dropped in value for a period of time before roaring back. But there are nevertheless some companies Buffett has sold at a loss, and those are described in further detail.
Berkshire's investments in Solomon, General Re, NetJets, and Pier 1 Imports (PIR) are considered mistakes by the author. These investments are critiqued and analyzed. In a couple of cases, Buffett has had to take over active management of the firms, and managed to turn some of them into successes. But these are still deemed mistakes, as the author asserts that Buffett would not have bought in had he known what was in store.
However, in many of the cases, the incidents which caused these investments to go wrong would have been difficult to foresee. A rogue trader (Solomon) and hidden liabilities (General Re) would be very difficult for investors to prevent from occurring, so it's not immediately clear what the reader is to learn from these mistakes.
Chapter Seven:
The public often views Buffett as pro-shareholder and a fan of good corporate governance. But Janjigian points out that Berkshire falls short on several fronts when it comes to corporate governance.
For example, governance experts suggest that a company's CEO and Chairman position should be occupied by different individuals, but this is not the case at Berkshire where Buffett holds both roles.
Berkshire (until recently) also didn't meet governance standards when it came to the number of independent directors on its board. As recently as 2002, the board of Berkshire consisted of only 7 individuals. There were three Buffetts on this board, along with Charles Munger and Richard Olson (a partner at Munger, Tolles & Olson LLP). Therefore, clearly 5 of the 7 board members were not independent.
In fairness to Buffett, however, he disagrees with the definition of "independent" when it comes to directors. Buffett believes that while those whose association with the company results in their receiving a large portion of their income from fees for being directors are regarded as independent by the experts, they are actually the least useful. Instead, Buffett would rather have directors with a substantial investment in the company, since these individuals are most likely to be on the side of shareholders when it comes to company matters.
Buffett has also failed in his succession planning according to Janjigian. For most of Berkshire's existence under Buffett, it has not had a plan in place. It should be noted that currently Berkshire does have clear succession planning, but it took an NYSE requirement to get this process started. Even so, no one person will do Buffett's job, as his job will be split between someone who runs the business, and someone who runs the investment operation. As such, in all of Buffett's years at the top of Berkshire, he has not trained anyone who can truly take over his position.
Chapter Eight
This chapter is devoted to a discussion of stock options. The author critiques some of Buffett's takes on options, while applauding some of his suggestions. While Janjigian doesn't come right out and say it, it appears he is not in favour of the now required expensing of stock options.
While Buffett has made it clear that he believes options should be expensed, the author takes issue with Buffett's logic. Because the value of options are difficult to measure at the date of grant (since they can end up being worth nothing, or being worth a whole lot more than expected), the author's take is that expensing them is not as straight forward as it is for other uncertain expenses such as depreciation (where the cost of the purchased good is at least known).
The author believes the real problem is abuse of options. Excessive grants, re-pricings and backdating are all forms of abuse that shareholders should be looking to curtail, rather than focusing their energies on forcing option expensing. Diluted Earnings Per Share already accounts for outstanding options, so the author suggests expensing is unneccessary.
The mandatory expensing of options has lead to a drop in this form of compensation. The author seems to believe this will stifle new companies, many of which cannot afford to pay enough cash to attract top managers. Unfortunately, this argument seems rather flimsy, as it could also be taken to the next step in a claim that depreciation should not be "expensed", since this would curtail necessary capital investments.
Although the value of options is uncertain, Buffett's argument is that we should make a best effort to put some expected value on them, rather than have the income statement completely ignore them.
Chapter 9:
The author goes on a full scale attack of Buffett's position on taxes.To set the background, Buffett believes the rich should pay a higher percentage of their income in taxes. He argues this because they can afford it, while others who are less well off can really make use of the money they pay in taxes. Buffett also believes in high estate taxes. Why tax living people, who could use the money to improve their lives, when you can tax those who can no longer gain from their material wealth?
Janjigian attacks Buffett on the death tax issue by pointing to the fact that Buffett is giving most of his estate away, and therefore will not pay much of a death tax himself. It seems strange to attack Buffett's own activities: even though Buffett is arguing for higher estate taxes, surely he can make his own decisions within the rules that currently exist. The author also quotes a couple of economists that believe a higher estate tax is unfair and would cause wasteful spending.
The chapter is surprisingly lacking a discussion of the standard economic argument for flat taxes (where the rich pay a similar percentage to the poor) which is incentive driven. By allowing workers to keep more of what they earn, the most productive workers are encouraged to work more, which benefits the entire society due to their value add. Of course, this leads to a higher disparity between the rich and the poor which is unpopular politically.
Chapter 10
In this final chapter, a discussion takes place about whether management should give earnings guidance. Buffett's position on this matter is made clear. He believes that when managers give quarterly guidance (i.e. tell analysts what the next quarter's earnings are expected to be), it inappropriately encourages managers to focus on short-run profits rather than the business in the long-run.
It should be noted that providing guidance is not mandatory, but certain firms do so voluntarily. While Janjigian agrees that short-run earnings management is a bad idea, and that the best way to manage is with a long-term horizon in mind, he doesn't believe guidance is what causes short-term thinking. Janjigian argues that analysts will form expectations regardless of whether management offers guidance, and therefore the incentive to manage in the short-term is present whether management offers guidance or not.
The author argues that investors want to avoid price volatility and that is why these investors are against guidance. (However, it should be noted that when we met with Buffett, he was very clear that he likes volatility, because that's what allows him to profit by buying low!) Janjigian argues that volatility is higher for companies that don't offer guidance, since management is in the best position to offer the best forecast of the next period's earnings.
Finally, the author cites studies that suggest stocks drop after managements announce they will no longer offer guidance. The authors of the studies believe dropping guidance sends a signal to investors of bad news ahead, which causes the stocks to drop.
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