Dear Value Investors
Warren Buffett will be paying US$779 Million to purchase Caixabank’s life insurance operation, VidaCaixa. Caixabank is one of Spain’s stronger lenders, but has been hurt by the collapse in the country’s real estate market. What will Warren gain? VidaCaixa will continue servicing the portfolio, but will be obliged to hand over its cash flows to Berkshire Hathaway. If you have read Berkshire’s Letters to its Shareholders, Warren loves the insurance business as it collects money upfront from its clients and it’s not obligated to pay back anything until the client make claims. Imagine you as an insurance client paying premium to your insurance company. Guess what will the insurance company do with your premium? Warren called such premium collected “Float” where he can used to invest. Berkshire has also signed a series of reinsurance deals with other insurers, including AIG, Lloyd’s of London and Swiss Re.
Here are some examples where Warren became “greedy when others are fearful”:
1) Sep 2008 – Purchase of Goldman Sachs
Berkshire purchased $5 billion of preferred stock, and it will also receive warrants to purchase $5 billion of common stock with a strike price of $115 per share. Berkshire has five years to exercise the warrants. Buffett will be paid a 10% dividend on his shares. As of 30 Nov 2012 GS’s closing price, it’s US$117.79. Ignoring the possible capital appreciation, he would have a sure-gain of 10% just on the dividends. However, do note that one of the criteria that Warren would invest in any company is that the company must have a ‘Durable Competitive Advantage‘. In his own words – “Goldman Sachs is an exceptional institution,” said Buffett in a statement. “It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.” But note that Warren made his purchase during that time because he knew that the Congress will pass $700 billion bailout. “If I didn’t think the government was going to act, I would not be doing anything this week,” Buffett told CNBC.
2) Oct 2008 – Purchase of General Electric
Berkshire Hathaway acquired $3 billion in preferred stock. Buffett’s firm will collect a 10% dividend on those shares. At the same time, Berkshire Hathaway would receive warrants to buy $3 billion of common stock at $22.25 per share for up to five years starting 2008. As of last Friday’s closing price, GE traded at US$21.13. So what is GE’s ‘Durable Competitive Advantage’? Warren called GE “the symbol” of American business with strong global brands and business divisions. “I am confident GE will continue to be successful in the years to come,” Buffett said in a statement. To raise money for his purchase, he sold J&J shares near the end of 2008 to help fund investments in $8 billion of preferred shares and warrants of General Electric Co. and Goldman Sachs Group Inc.
3) 2009 – Purchase of Well Fargos
Berkshire increased its stake in the bank by about 4.3 percent in the first quarter of 2009 to 302.6 million shares. Why did Warren buy WFC during this period where investors felt that there are low interest rates for lending as well as possible risky lending? Why Warren loves WFC? Read http://www.cnbc.com/id/48093735/Warren_Buffett_Shuns_Investment_Banks_Embraces_Wells_Fargo & http://money.cnn.com/2009/04/19/news/companies/lashinsky_buffett.fortune/index.htm.
4) Aug 2011 – Purchase of bank of America
Berkshire bought $5 billion of preferred stock that pay a 6 percent annual dividend, and receive warrants for 700 million shares that it can exercise over the next 10 years. Bank of America has the option to buy back the preferred shares at any time for a 5 percent premium. So what is Bank of America’s ‘Durable Competitive Advantage’? In Warren’s own words: “Bank of America is a strong, well-led company, and I called Brian to tell him I wanted to invest in it,” Mr. Buffett said in a statement. “I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them.” In the midst of the subprime crisis in 2007, Berkshire bought 8.7 million shares, quickly increasing the stake to 9.1 million shares but Warren sold all of them in 2010.
Even though Warren did mentioned “Be greedy when others are fearful. Be fearful when others are greedy” but please do not follow this principle and his purchase blindly. The GE, GS and VidaCaixa purchase are just some examples that he invested which are preferred stocks (with fixed dividend payout and warrants issued), NOT the common stocks that retail investors have access to. In addition, in Value Investing, it’s utmost importance to know the company’s ‘Durable Competitive Advantage’ and also your own ‘Circle of Competence’ (ie. Do you understand the business?) before you invest. Another key where Warren B uffett and Charlie Munger mentioned is ‘Capable Management’. Warren will know the management by playing Bridge with them but retail investors obviously do not have such privilege. What we may do is to read more about how the management of a company handle any crisis.
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Founder, Mind Kinesis Value Investing Academy