Tuesday, May 5, 2020

Analyzing the 2018 Annual Report by Warren Buffett

Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses – our economic "trees," so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty.

Fortunately, it's not necessary to evaluate each tree individually to make a rough estimate of Berkshire's intrinsic business value. That's because our forest contains five "groves" of major importance, each of which can be appraised, with reasonable accuracy, in its entirety. Four of those groves are differentiated clusters of businesses and financial assets that are easy to understand. The fifth – our huge and diverse insurance operation – delivers great value to Berkshire in a less obvious manner, one I will explain later in this letter.

Before we look more closely at the first four groves, let me remind you of our prime goal in the deployment of your capital: to buy ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics. We also need to make these purchases at sensible prices.

Sometimes we can buy control of companies that meet our tests. Far more often, we find the attributes we seek in publicly-traded businesses, in which we normally acquire a 5% to 10% interest. Our two-pronged approach to huge-scale capital allocation is rare in corporate America and, at times, gives us an important advantage.

In recent years, the sensible course for us to follow has been clear: Many stocks have offered far more for our money than we could obtain by purchasing businesses in their entirety. That disparity led us to buy about $43 billion of marketable equities last year, while selling only $19 billion. Charlie and I believe the companies in which we invested offered excellent value, far exceeding that available in takeover transactions.

Despite our recent additions to marketable equities, the most valuable grove in Berkshire's forest remains the many dozens of non-insurance businesses that Berkshire controls (usually with 100% ownership and never with less than 80%). Those subsidiaries earned $16.8 billion last year. When we say "earned," moreover, we are describing what remains after all income taxes, interest payments, managerial compensation (whether cash or stock-based), restructuring expenses, depreciation, amortization and home-office overhead.

For example, managements sometimes assert that their company's stock-based compensation shouldn't be counted as an expense. (What else could it be – a gift from shareholders?) And restructuring expenses? Well, maybe last year's exact rearrangement won't recur. But restructurings of one sort or another are common in business – Berkshire has gone down that road dozens of times, and our shareholders have always borne the costs of doing so. Abraham Lincoln once posed the question: "If you call a dog's tail a leg, how many legs does it have?" and then answered his own query: "Four, because calling a tail a leg doesn't make it one." Abe would have felt lonely on Wall Street. Charlie and I do contend that our acquisition-related amortization expenses of $1.4 billion (detailed on page K-84) are not a true economic cost. We add back such amortization "costs" to GAAP earnings when we are evaluating both private businesses and marketable stocks.

Berkshire's runner-up grove by value is its collection of equities, typically involving a 5% to 10% ownership position in a very large company. As noted earlier, our equity investments were worth nearly $173 billion at year-end, an amount far above their cost. If the portfolio had been sold at its year-end valuation, federal income tax of about $14.7 billion would have been payable on the gain. In all likelihood, we will hold most of these stocks for a long time. Eventually, however, gains generate taxes at whatever rate prevails at the time of sale.

A third category of Berkshire's business ownership are companies in which we share control with other parties. Our portion of the after-tax operating earnings of these businesses – 26.7% of Kraft Heinz, 50% of Berkadia and Electric Transmission Texas, and 38.6% of Pilot Flying Jets – totaled about $1.3 billion in 2018.

In our fourth grove, Berkshire held $112 billion at year-end in U.S. Treasury bills and other cash equivalents, and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities. We have also promised to avoid any activities that could threaten our maintaining that buffer.

I believe Berkshire's intrinsic value can be approximated by summing the values of our four asset-laden groves and then subtracting an appropriate amount for taxes eventually payable on the sale of marketable securities. You may ask whether an allowance should not also be made for the major tax costs Berkshire would incur if we were to sell certain of our wholly-owned businesses. Forget that thought: It would be foolish for us to sell any of our wonderful companies even if no tax would be payable on its sale. Truly good businesses are exceptionally hard to find. Selling any you are lucky enough to own makes no sense at all.

Beyond that, much of our ownership of the first four groves is financed by funds generated from Berkshire's fifth grove – a collection of exceptional insurance companies. We call those funds "float," a source of financing that we expect to be cost-free – or maybe even better than that – over time. We will explain the characteristics of float later in this letter.

Let's now look further at Berkshire's most valuable grove – our collection of non-insurance businesses – keeping in mind that we do not wish to unnecessarily hand our competitors information that might be useful to them.

I will stick with pre-tax figures in this discussion. But our after-tax gain in 2018 from these businesses was far greater – 47% – thanks in large part to the cut in the corporate tax rate that became effective at the beginning of that year. Let's look at why the impact was so dramatic.

Begin with an economic reality: Like it or not, the U.S. Government "owns" an interest in Berkshire's earnings of a size determined by Congress. In effect, our country's Treasury Department holds a special class of our stock – call this holding the AA shares – that receives large "dividends" (that is, tax payments) from Berkshire. In 2017, as in many years before, the corporate tax rate was 35%, which meant that the Treasury was doing very well with its AA shares. Indeed, the Treasury's "stock," which was paying nothing when we took over in 1965, had evolved into a holding that delivered billions of dollars annually to the federal government. Last year, however, 40% of the government's "ownership" (14/35ths) was returned to Berkshire – free of charge – when the corporate tax rate was reduced to 21%. Consequently, our "A" and "B" shareholders received a major boost in the earnings attributable to their shares. This happening materially increased the intrinsic value of the Berkshire shares you and I own. The same dynamic, moreover, enhanced the intrinsic value of almost all of the stocks Berkshire holds.

Which suggests that we return to the performance of our non-insurance businesses. Our two towering redwoods in this grove are BNSF and Berkshire Hathaway Energy (90.9% owned). Combined, they earned $9.3 billion before tax last year, up 6% from 2017. You can read more about these businesses on pages K-5 – K-10 and pages K-40 – K-45.

Our next five non-insurance subsidiaries, as ranked by earnings (but presented here alphabetically), Clayton Homes, International Metalworking, Lubrizol, Marmon and Precision Castparts, had aggregate pre-tax income in 2018 of $6.4 billion, up from the $5.5 billion these companies earned in 2017.

The next five, similarly ranked and listed (Forest River, Johns Manville, MiTek, Shaw and TTI) earned $2.4 billion pre-tax last year, up from $2.1 billion in 2017.

The remaining non-insurance businesses that Berkshire owns – and there are many – had pre-tax income of $3.6 billion in 2018 vs. $3.3 billion in 2017.

Over time, Berkshire's funding base – that's the right-hand side of our balance sheet – should grow, primarily through the earnings we retain. Our job is to put the money retained to good use on the left-hand side, by adding attractive assets

12 Words of Wisdom from Warren Buffett

Don't Gamble
Warren is more interested in making sure that an investment results in the return of capital as well as the return on that capital. In other words he hates risk and gabling. He wants to make sure he takes the shots only when he knows what he is getting into. One of this famous quotes is that the No. 1 Rule of investing is to never lose money and the No. 2 Rule is to never forget Rule No. 1. Risk comes by not knowing what you are doing so always manage your risk.
 
Margin of Safety
Even when you have done you due diligence and narrowed down on a particular stock there is still a chance that you will make a mistake and the price will still fall further. So you should always have a margin of safety when you buy an investment. Have a purchase price so attractive that a mediocre sale becomes profitable. Look at companies which have sales and revenues on an upward trajectory. Buy companies with high profit margins. Look for retained earnings and good equity build-up. Then try to buy at a price which is closer to the book value. Avoid companies with a lot of debt. Come up with an intrinsic value of a business you buy based on the cash flow of their future earnings discounted to the present value.
 
Circle of Competence
Buy what you know. Stay invested only in companies you know best about based on your own circle of competence. Never buy a stock because someone else recommended it to you. Make your own decisions.
 
Do your Homework
You should be able to explain to your grand mother what business you are buying into. Make sure you do your analysis on fundamental, technical and quantitative methods. Come up with an intrinsic value of the business based on scientific techniques. If the company facts change then change your opinion quickly. You should Buy and Hold buy never Buy and Hope.
 
Be Contrarian
Mr. Market will usually come to you to purchase your farm or sell you his. Try to purchase from him when the over all conditions are most gloomy. Be Greedy when everyone else is fearful. Such buying opportunities come once in a while and when they come it does not rain it pours and make sure you have your buckets ready for that day. Avoid the herd instinct. Be confident but never over confident. Avoid complexity and keep it simple. You only have to do a few things right as long as you don't do too many thing wrong.
 
Buy Good Businesses
Time is a friend of a good business and an enemy of a mediocre one. So make sure you buy the best in class out there. It is always better to buy a wonderful company at a fair price rather than buying a fair company at a wonderful price. Buy companies that have a product or a service which is the best of the best or in other words the business has a moat which other competitors do not possess.
 
Keep Good Company
Always associate your self with people who are smarter than you. Even if you don't know where you are going you will still reach the destination just by sticking around with them. Buy companies with management which is honest. Management that takes rational decisions and returns capital to shareholders by dividends or stock buybacks.
 
Be an Investor
Be ready to buy a company that you are willing to hold for the next 10 years. If you don't plan to hold a company for 10 years don't even spend 10 minutes wasting your time on it. Invest as if you can hold the company even if the markets remain closed for the next decade. Never trade in and out. Remember that motion in investment causes high transaction fees and that eats into the returns. Hence sometimes it may be better to buy an index fund.
 
Buy a business
Buy into a stock as if you are buying into that business. Know everything there is to know about the company. Be able to read into the financial statements of the companies you invest in. Be able to know what markets they operate in and how the market forces affect their business.
 
Fail Fast
Try to learn from your mistakes. It is ok to be wrong but never ok to stay wrong. If you make a mistake just admit it cut your losses early and move forward. Never worry or dwell in the past. Just make sure you learn from your mistake and treat the loss as the tuition for that learning. Remember never make the same mistake twice. Time is of essence so know the difference between what is important and what is trivial. Think outside the box for novel solutions to problems. Never settle for status quo. There is always a better way to do things.
 
Compounding is like Magic
Warren bought his first share on Mar 11 1942. He feels that if he had invested that money in an index fund which invests the profits and hence compounds the gains the same investment would have been much more. He strongly believes in the power of compounding.
 
Don't Overdiversity
Risk can be reduced when you diversify however make sure there is a limit to diversification. Ignorance is not an excuse for diversification. Try to scale in and out of your positions. Invest a little amount every month. If you are not sure what to invest in then always fall on a low cost S&P index fund. Diversify into growth and value. Diversify into stocks and bonds. The key is to know what you are invested in at all times.

Tuesday, April 28, 2020

What are Google's Four Main Areas of Focus in 2020

At Google, we'll continue to be focused on the 4 key...…
 
First, creating the most helpful products for everyone
 
Second, providing the most trusted experiences for our users.
 
Third, executing at scale and be nimble
 
And finally, creating value, optimizing and prioritizing strategic areas of investment

Monday, April 27, 2020

What is Chaos Theory?

Financial market consists on 2 groups of people. One that think the market is 100% efficient and the other which thinks it is completely random.
So who is right?
The truth is that the markets are complex and chaotic systems and their behavior contains both a efficient and a random component. Therefore we can make a realistic stock market forecast, although it is precise only to a certain extent.
Complex chaotic systems are vulnerable to minor changes (butterfly effect applies) causing a big perturbation in the system pushing it far away from its equilibrium. This is called the butterfly effect. So if anything small happens anywhere in the world the financial markets are usually the first ones to be affected.

Wednesday, April 8, 2020

The most expensive bug in history...

 

The development team gets a call by CEO that they need to implement a new feature in SMARS (their system) to take trades from dark pools as well in addition to the regulated markets.

 

The development team had 30 days to comply with the new rule. Although the CEO himself was not in favour of this new feature he had to anyway go for it as it meant retaining existing business.

 

The release date for the new feature in the system was set to 9:30 AM EST on August 1, 2012

 

The plan was to deploy the new system behind a feature flag the week before the deadline; when the market opened on August 1, they'd simply turn it on.

 

At 9:30 AM EST on August 1, the Knight developers did just that: they enabled the feature flag, and SMARS began to route orders through to the RLP—they were live!

 

But something was wrong. Their charts showed anomalous spikes in trading activity on the open markets. At 9:34 AM, the NYSE called  Knight was executing a lot of trades—so many, in fact, that trading volumes for the entire market were double their normal level.

 

To make matters worse, the trades they were making didn't make sense. SMARS appeared to be buying high and selling low. At the current rate, they were losing thousands of dollars per second.

 

Alerted to the problem, Knight's Chief Information Officer called the top operations engineers together to try to identify the root cause. The rogue orders seemed to be originating from the new RLP router code, but no one could pinpoint the bug.

 

20 minutes had screamed by since the market opened, and the unauthorized trades executed by SMARS already totalled well into the billions of dollars. It was time to roll back, and ask questions later.

 

With a shaky sense of relief, the operations team scrambled to check out the last known stable version of SMARS and deploy it to their 8 production servers.

 

To their horror, as soon as the router restarted, trading volumes on the NYSE spiked again: they were now executing even more trades than before.

 

At 9:58 AM, the Knight developers shut down SMARS entirely. It had been 8 minutes since rolling back the RLP code, and 28 minutes since the market opened.

 

They'd just lost their company $460 million dollars.

 

But what actually happened?

When the developers of Knight's high frequency trading algorithm replaced some unused legacy code, they repurposed a feature flag which had been used to disable it.

 

The deployment was a success for 7 of their 8 servers, but the deploy to the 8th server failed silently, meaning that one server was still running the legacy code. When they enabled the feature flag, 7 servers operated as expected; the 8th executed the legacy code, which should have never run in production.

 

Instead of re-deploying the new code to the 8th server, they decided to roll back to the last known good state. Unfortunately, they didn't know that the problem was the feature flag, and it didn't cross their minds to turn it off. When the old system was re-deployed, every server began to run the legacy code, dramatically compounding their losses.

 

 

Where did they go wrong?

 

The Knight developers should have never allowed dead code to remain in their app for so long. Had they been more proactive, they could have easily avoided catastrophe. Reusing a feature flag was a dumb mistake that just shouldn't have been made. The developers weren't entirely to blame, though—if there's one certainty in life, it's that we will make mistakes.

 

 

When they deployed SMARS, they didn't have an automated deployment pipeline, instead relying on their engineers to manually deploy the new code; as a result, they missed an important step on the fated 8th server. When the first mistake led to a crisis situation, their monitoring was inadequate, and they didn't have documented incident response procedures which could have prevented them from making an even worse mistake under pressure.

 

 

 

Tuesday, March 31, 2020

Why was Lehman dumped and AIG Saved during 2008?

Lehman came back from a near death experience during 1998 LTCM Collapse. They then got into risk management and got their acts together. However slowly all of that again started to fade and due to management arrogance and hubris they defied risk. This led to their collapse in 2008. AIG was more of a systemic entity backing a lot of collateral from other banks. Being more of a systemic risk it was saved.

 

 

https://knowledge.wharton.upenn.edu/article/the-good-reasons-why-lehman-failed/

Tuesday, December 3, 2019

Qualcomm Unveils the lower prices 765G

Mid range phones and 5G here we come…
 
It supports 3.7 Gbps download speeds, mmWave, Sub 6 GHz, Dynamic Spectrum Sharing, NSA, SA, and carrier aggregation.
 
Source: Qualcomm Snapdragon Summit 2019 
 
 
 

Wednesday, November 27, 2019

Is Cash Really King?

"The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worthless over time. But good businesses are going to become worth more over time."

 

The above words are from the Oracle of Omaha. However, currently he is sitting on a boatload of cash around 125 Billion. Does that give any hint to the investors?

Machine Programming

Imagine dictating a problem statement to a computer and software gets generated that provides a solution. That is what machine programming is all about. Although around since the 1950s, it is now at an critical juncture.

 

Sunday, November 10, 2019

Weekly Roundup Nov W1 2019

Oil was up and yields were up too with a 10 year at 1.82

Yields up (means bonds prices were down) and hence risk on situation.

Since yields were up so Dollar would naturally be higher and hence gold took a downward move.

Gold was down also because of trade news on china

 

Yields are at the highest since Aug

 

 

Thursday, August 8, 2019

What will be impact of US China Trade Situation

U.S. Debt Will Grow: Foreigners will not be able to buy much of US issued debt (Treasuries and Bonds) so US investors may be forced to buy it.

 

Foreign Capital Inflows Will Fall: Foreigners will have less dollars to put back in the US economy.

 

Cost May be high: Tariffs will increase the costs.

 

Slowdown and Uncertainty : Economy may slow due to people slowing spending

 

Politics will be Key : Any uneasy political dialog will hurt the entire situation.