This was the topic at the recent MOI Global Zurich chapter dinner I attended. Here I summarize my notes and thoughts on this topic.
I understand capital allocation as follows:
How do companies spend their limited resources, be it capital, time, or mental resources, so that they create the maximum amount of value per invested unit of capital?
So it’s all about value creation, efficiency and high returns on invested capital, however you want to define it.
So how to identify a great capital allocator? First, try to find people with a solid record of value creation. Growth in earnings per share or free cash flow per share could be useful metrics. Exceptional customer loyalty, products that solve real problems, or a full R&D pipeline with promising improvements could be qualitative factors to look for.
One shortcut is to look for owner-operators. People who own a large stake of their company and are the driving force. Especially if those people already have a strong track record.
Then we discussed a number of topics and companies.
Amazon Jeff Bezos was mentioned as a great capital allocator. Because he is obsessed with creating customer value, and takes a very long-term view. He has a deep understanding of capital allocation from his 8 years working on Wall Street (including working at a hedge fund). Plus, he is the owner-operator.
Disruption / Innovator’s Dilemma Disruption is a real challenge. Many companies are faced with the Innovator’s Dilemma, being stuck with path-dependancy and an inability to cannibalize their still profitable, but increasingly obsolete, business units. Steve Jobs was a master of breaking this dilemma. Mark Zuckerberg seems to be pretty good at it as well.
BMW vs. Tesla So what should a company like BWM do, faced with the disruption created by electrification and autonomy, or more generally speaking, by software and data? Should they compete with the Google’s and Tesla’s of the world on software, and potentially lose a lot of money, or would it be better to milk the current cow and slowly decline?
Warren Buffett and his textile business Warren Buffett was faced with the same situation in his early textile business. He did a very sensible thing. He did not try to save the business at all cost. He took the profits, and reinvested them more productively. In his case, buying great and profitable companies like banks and insurance companies. And when his textile business started to lose money, he shut it down completely. He faced the facts and acted accordingly. He wasn’t romantic about it.
Mergers & Acquisitions Acquisitions only make sense when done sensibly. Buy great assets, and don’t overpay. A lot of times, mediocre acquisitions are made, for way too much money.
Stock buybacks & Dividends If its own stock is undervalued, it creates value for a company to buy back shares. If buybacks don’t make sense, paying a divided is better than acquiring a mediocre business, or starting a mediocre project.
Apple What should a company like Apple do? So far they have been heavily buying back shares and paying out dividends. So it seems that the current management can’t find better opportunities internally or externally to deploy the cash.
To summarize, there seems not to be a single way to identify great capital allocators. It all depends on the specific circumstances. Personally, I like the owner-operator approach. This might be a great shortcut to find, and then partner with, great allocators. In fact, when I look at my personal portfolio, this is exactly what I ended up doing in a lot of cases.
The style of investing that speaks most to me is value investing, as practiced by Warren Buffett and Benjamin Graham. I’m often asked: “What is value investing exactly?”
Here is my understanding of the core principles:
Have more purchasing power in the future The goal of all investing is laying out money today, so that you can enjoy more purchasing power in the future. The principle is: Instead of eating the seeds, plant them, so one day, you will have plenty more to enjoy.
Investing vs. Speculation The goal is to be an “investor” and not a “speculator”. Here is the definition by Benjamin Graham: “An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative.” (The Intelligent Investor)
A stock is a partial ownership of a business A stock is not just an abstract ticker symbol with a constantly moving price. It is a partial ownership of a business. So no matter whether you are buying 0.000001%, 10% or 100% of a business, the decision process should be quite similar. You have to know what the whole business is worth, so that you can determine what each share of the business is worth.
Mr. Market is here to serve you, not to guide you Treat the market as your manic-depressive business partner called “Mr. Market“. He is emotional, euphoric, moody, and often irrational. Every day, he quotes you a new price for his shares. You can reject him every day, and the next day he always comes back with a new price. You can never know what price he will offer next and you don’t know why he offers you the price that he does. Your job is to simply listen to him every day, and only buy if when he offers you a low price. As opposed to “market timing”, this is “market pricing”. You simply recognize a good deal when you hear one, but can never know when it happens.
Margin of safety Always have a margin of safety, as a buffer for errors and unforeseen situations. The principle is simple: If you are building a bridge that is supposed to support 20 tons of weight, you don’t build it for 21 tons. You build it for 40 tons, to have plenty of margin. The same is true for value investors: they try to be very conservative in their calculations. They don’t buy a stock because they think it’s 6% undervalued. They demand 50%.
Buy one dollar for 50 cents To summarize, and to quote Warren Buffett: “All investing is value investing.” In fact, Warren Buffett or Charlie Munger don’t even call themselves value investors. They simply master these principles. The goal is to find something worth one dollar and buy it for 50 cents. And even if your assessment was wrong and it turns out to be worth only 50 cents, you at least didn’t lose any money, thanks to your wide margin of safety.
Results By applying these principles, Warren Buffett has grown his net worth from $10,000 when he was 19 years old to more than $80 billion today, compounding at an average rate of more than 20 percent per year for more than 60 years straight.
If you’ve invested $1,000 into Warren Buffett’s publicly traded holding company Berkshire Hathaway in 1965, you would currently have $4.3 million.
So these principles are not just theory, they are achieving wonderful results.
It took me 11 years after becoming a Warren Buffett enthusiast to finally attend my first Berkshire Hathaway Annual Meeting in Omaha, Nebraska. Here are my notes and my guide for first-time attenders.
How to Attend the 2020 Berkshire Hathaway Annual Shareholders Meeting
This guide by The Investors Podcast (TIP) is a great starting point. But there are a lot of additional details to figure out. Here is my guide for first-timers:
When to plan the trip? Next 2020 meeting will take place on Saturday, May 2, 2020. It’s advisable to plan the trip as soon as possible, optimally as early as October or November. I planned my trip in January and it was already quite difficult to find reasonably priced hotels (I was still lucky though, see below).
Credentials / Tickets You don’t need to be a shareholder to get tickets, and there aren’t any further controls once you have tickets. The easiest way is to order them on eBay directly from Berkshire Hathaway (brka_b is their user name) and send them to your hotel address (they only cost $5 including shipping, but they only ship to the US. Also, they sell out rather fast, so I recommend to monitor eBay closely). If you are a shareholder, then simply print out a recent broker statement, bring a matching ID/passport and pick them up at the CHI Health Center on Friday before the meeting at the “Will Call”. You can pick up as many as 4 credentials, so not all of your friends need to stand in line. If you can’t pick up your ticket on Friday, you can ask a friend to pick up an extra for you. You can also check Craigslist.
Accommodation / Hotels I highly recommend staying in Council Bluffs, right across the river in Iowa. I booked in January and was lucky to find a decent hotel for just $55 per night. It only takes 10 minutes to go Downtown and the traffic was always smooth, as you take the freeway most of the way. If you are on a low budget or like to stay with locals, you might also consider Couchsurfing. If budget is not an issue, then you might stay near the Old Market area, so you have everything in walking distance.
Rental Car / Parking A rental car is highly recommended, and only costs around $30 per day. The alternative is using Uber/Lyft, but this can get quite expensive if you want to see many things. I never had parking problems, even in Downtown. Mostly you have parking meters which cost $1.25 per hour (payable with credit card or cash). I downloaded the “ParkOmaha App” which made the process even easier. (If you don’t mind walking 10-15 minutes, you can park for free on the bridge next to the Durham Museum. That’s what I did most days. But don’t tell others ;)
Join a WhatsApp / Telegram group One of the best things I did was to join WhatsApp / Telegram groups. That way I always knew what’s going on and was never alone. We ended up being a group of 4-5 people that did most things together. One group I found on the TIP Forum, and the other through Guy Spier’s mailing list. I’m pretty sure there are others as well.
How to prepare for the meeting If you want to stand in line very early, I recommend to buy a $10 camping chair from Walmart. I did and it was a very good investment. Some Chinese people also brought blankets to lie on the ground, but I’d say this is optional. Other than that no special preparations needed. Pro tip: don’t drink anything to avoid having to go to the bathroom.
When to stand in line for the meeting There are multiple entrances. Mohnish Pabrai recommends to go to the South Entrance, so I did that. We were there at 3.00am, which guaranteed us excellent seats. I think 3.30am would have been fine as well. Most people come after 4.00am and the line will get very long after that. I was sitting in my chair and was even able to take a few naps, as did several Chinese people next to me. In fact, most of the very early people at the South Entrance were Chinese.
How to get great seats When you pass the security check at the South Entrance, take the stairs down one floor, then continue straight until you see the Lexus Club. Take any door to the left to enter the hall (the sectors are not separated, so you can move freely within the hall). If you feel lucky, you might go all the way down to the ground floor and try to get a front row seat. We didn’t do that. We chose Sectors 104 which offers a fantastic view.
Want to see Warren Buffett up close? After you have secured your seats around 7.15am, I recommend to go the the Exhibit Hall. Warren often takes a walk trough the hall before the meeting starts. The movie starts at 8.30am, so there is plenty of time to look for Warren. Don’t forget to go to the restroom before the event starts. The morning session is nonstop until noon.
Backpack / Security CHI Center’s clear bag policy doesn’t apply to the Berkshire Hathaway meeting. You can bring a backpack. Full bottles are not allowed (empty ones are okay).
Events / Meetups There are a lot of events and meetups, and the best way to stay up to date is to join a WhatsApp/Telegram group. I highly recommend doing the 5k on Sunday. It’s a very nice and quite short run. As we’re in the US I expected 5 miles, and was pleasantly surprised to see the finish line after just 5 km :) After that I went to Borsheims to play against ping pong champion Ariel Hsing, which was a lot of fun.
Restaurants I really liked Jams in the Old Market. They have great salads. I also liked the Old Chicago pizza place in the Old Market. On weekdays they have great lunch deals.
Other fun things The Hollywood Candy store was fun. That’s where Buffett and Gates made the Sweet Nostalgia video. You can easily spend one or two hours there. Don’t forget to have a strawberry milkshake!
Disclaimer: All the above information is based on my 2019 trip. Things might change in the future, so keep your eyes and ears open.
Key Learnings from 2019 Meeting
Write down your thesis Before you buy a stock, write down: “I’m buying this company for [insert market cap, e.g. $500 billion], because…” If you can’t answer this question, don’t buy the company. Remember: A stock is not a piece of paper, it’s a part ownership of a business.
Broad vs. narrow circle of competence You need to find what you can understand. There is much more competition today than when Buffett started. It’s always a good strategy to specialize. Read as much you can. Figure out what you are good at. You need an edge. Be smart in spots and try to stay around those spots. Having one edge is enough.
Environmental, social and governance (ESG) Don’t spend time creating ESG committees and writing long reports. Simply do the right thing. Example: Berkshire Hathaway’s utility is on a path to soon produce 100% renewable energy in Iowa.
The Future Performance of Berkshire Hathaway “Berkshire Hathaway won’t be the biggest compounder by a long shot. But it will and continue to be a very safe way to make decent returns for a long time.” — Warren Buffett
Keep trying things “If you keep doing enough things, some of them will work out.” — Warren Buffett
Figure out what works “Figure out what works, and go do it.” — Charlie Munger