April 25, 2015

The Businesses Keep Growing and Stocks Are Falling

Treasury Businesses in We Rule by Ngmoco

We just keep earning profit, reinvesting that profit, and doing it again. Wash. Rinse. Repeat. It's very similar to what I do in that Ngmoco "We Rule" game I play on the iPad at the office during breaks. (This is the financial district in my kingdom with gold bricks piled up in the streets.)

It’s been a great week, both personally and professionally.  The stock market has been crashing as a result of the Greece debt crisis once again threatening to send everything into a tailspin, which gave me a chance to buy some more shares of Johnson & Johnson for a personal joint brokerage account I hold with Aaron, and just a moment ago, I entered a market order for shares of Berkshire Hathaway for one of the family’s operating companies.  (If I recall correctly, it was the beginning of the Greece crisis back in May when I last purchased Berkshire Hathaway shares.)  Other than those two positions, no comment because you know the rules: I try to only talk about enormous companies that are owned directly or indirectly by virtually everyone who has an index fund, 401(k) plan, or pension.

If we did hit another total meltdown caused by the Eurozone sinking, we have more than enough liquidity to survive it and thrive in the aftermath, so I’m not particularly concerned if I wake up tomorrow and either of the new investments are down by 70%.

That is just part of being a value investor that subscribes the philosophy, “I don’t really care what happens in the next year or two”.  I’m convinced that the long-term value I’m getting for every dollar invested is sufficient to justify the volatility risk given that we are about the most patient capital imaginable.  In the case of Berkshire Hathaway, it looks like it would take only 12 to 18 months for an investor buying at today’s prices to have an adjusted cost basis of around book value.  That means that in a little more than a year, you’d have effectively bought the firm at liquidation value (assets – liabilities) when the intrinsic value far exceeds book as a result of the high returns on non-leveraged capital earned by many of the wholly-owned subsidiaries.

Even If My Investment Thesis Is Wrong, I’m Comfortable Where We Are

What if I’m wrong?  What if tonight the world falls apart, Warren Buffett dies, and there is a magnitude 9.0 earthquake in California causing tens of billions of dollars in losses?  In that case, I’m willing to bet the underlying earnings power, cash reserves, corporate culture, and strong board serves as the margin of safety.  Sure, the company might take 3-5 years to recover fully. But I like the odds and I’m willing to risk a portion of our money.  It’s that simple.

The only hitch in my enthusiasm is that as a part of the secret project, I need to raise general cash levels at the companies to far above historical levels over the next 2-3 years.  Although things could change, it looks like I might be able to reveal our plans somewhere between December of 2012 and July of 2013.  As a result, no matter how cheap stocks get, I’m going to have to restrain myself and have a decent portion of surplus earnings removed from the operating businesses and parked in Treasury bonds, money market funds, and other short-term cash equivalents in some sort of holding entity.  When we make our move, it is that pile of liquidity that will allow me maximum flexibility and strength, giving me a much stronger position from which to negotiate the terms I desire.  But enough about that.

  • Elisaeth

    I have also been seriously excited about falling prices! Everyone around me is trying to “escape” – and they are escaping some excellent opportunities.  Thanks for teaching me a better way to look at this.

    • Joshua Kennon

      I’m glad you find it useful. In the next few days or weeks, I’m going to publish an article that explains how to value the entire stock market to determine if it is historically undervalued, fair valued, or overvalued, to help guard against overpaying. Of course, that doesn’t mean stocks can’t still become cheaper than they already are – in 1933, some major corporations were selling for less than the cash they had in the bank so if you could get your hands on enough stock, you could have taken over the business and then paid yourself back with its own money! – but it’s just one more tool for long-term investors to have in their toolbox. You might find that post interesting when it goes live.

      • Andrew

        Did you ever make that post or write the article? It would be a great read!