The S&A Digest: How Buffett Turned $10,000 into $366 Million

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(Top 10 highest-returning open positions across all S&A portfolios)

As of 07/02/2013

More signs of a top… an e-mail exchange today between Jeff Clark and our managing editor Brian Hunt:

-----Original Message-----

From: Jeff Clark

Sent: Friday, January 05, 2007 12:29 PM

To: Brian Hunt

Subject: nice call…

Hey Brian:

Nice call on the Templeton Russia Fund in DailyWealth the other day… it’s too bad there aren’t any shares available to short.

Best,

Jeff

* * * * *

Thanks, Jeff… I think it could easily plunge another 20% next week. Speaking of overvalued stocks, I just read an article by Dave Dreman in Forbes, and man, those exchanges are expensive… check out the Chicago Mercantile Exchange’s valuation.

– Brian

* * * * *

I know. The laggard is the Nasdaq (NDAQ), which I used to own since part of my brokerage firm had shares. Also, check out ICE – the commodity exchange. It’s crazy.

Also, I noticed CUBA, another closed-end country fund, at a 98% premium to NAV. What’s interesting is that most of the stocks in the portfolio trade in the U.S. So you could buy the stocks and short CUBA, and probably do quite well. Except that there are no shares of CUBA to borrow to get a short sale off…

– Jeff

Porter comment: The stocks of futures and derivative exchanges are by far the most expensive in the market right now. For the past few years, soaring trading volumes from hedge funds have made these incredibly profitable businesses.

Now, with commodity prices (chiefly oil) sinking, owners of these stocks could be in for a rough 2007. For instance, the Chicago Mercantile Exchange is trading for nearly 50 times earnings. The Intercontinental Exchange, which Jeff covered in Growth Stock Wire a few months ago, is trading for more than 100 times earnings.

I can’t imagine why anyone is willing to pay 50 or 100 times earnings for these exchanges when many of the world’s best companies are trading for 10 or 15 times earnings. As Jeff summed it up: Crazy.

New highs: American Eagle (AEOS), Macquarie Global (MGU), Quest Capital (QCC), American Real Estate (ACP), PowerShares Pharma (PJP), AutoZone (AZO).

"To Whomever, I have just been informed by the crack customer-service team at that abortion called a company that Investment Details has, in fact, been terminated as of two months ago. That, in my opinion, was an extreme error, as that publication hands-down was the best that your hack company put out, including the paid subscriptions. Do yourself a favor and pay Ferris some more money, you tightwad, penny-pinching idiots, and have him resume publication forthwith, as the tripe that exudes presently in the evening is nauseating beyond description, specifically that rag megalomaniac daily missive by that myopic self-hating moron, Porter Stansberry (whom I detest more than words can properly describe). Get Investment Details going again, you cheap bastards! P.S. Porter, I hate you like poison still, you jackass! Yes, POISON, overused metaphor just for you!" – Paid-up subscriber David Woodworth

"I THINK JOBS SHOULD GO TO JAIL. In addition to being greedy beyond reason, he is arrogant beyond belief… There is no amount of money he won’t spend on hiring the best legal gunslingers available! I sincerely hope we don’t end up with an OJ type of outcome. I admire your principled approach & outspokenness on this issue… About twenty-five years ago, I had the misfortune of confronting ‘Mr.’ Jobs concerning a $250,000 overdue receivable he owed to a small contractor that I was the controller of. He basically told me that he didn’t care & if I was unhappy, he would be happy to replace us with someone else! Let’s hope what goes around comes around." – Paid-up subscriber Roger Adcock

"Porter, When you come to Nashville for the Music City Marathon in April, my wife and I would be quite pleased if you would accept our invitation to be our houseguest during your stay. We have a lovely, large home in Smyrna, on the edge of Nashville, and would be thrilled to have you stay with us. Who knows, I might even be tempted to prepare a batch of my delicious smoked ribs in your honor." – Paid-up subscriber K.M.

Porter Comment: I’ll have to ask my wife first.

"My question is simple – is there an easier way of investing in the American stock market than having to use Australian Brokers and pay AUD$60 in and AUD$60 out? I would love to follow some of your picks and even at a later stage join the Alliance Group. Is there some way of going direct? Australia, as much as I love her, has only about 1% of the world’s money – If I am to achieve my goals, I have to go offshore." – Paid-up subscriber Noel Griffiths

Porter Comment: Do any subscribers have any advice for Noel?

How Buffett Turned $10,000 into $366 Million

Yesterday, I mentioned my sole financial goal for this year is to find one good, long-term, personal investment (in a common stock).

You might rightfully wonder why I would bother making a long-term investment. With all of the analysts that work here, with all of the information they uncover (much of it very profitable), why would I bother with "old-fashioned" investing at all? Why not just buy a bevy of Jeff Clark’s options? They’ve been earning more than 20% a year, on average and unannualized. Or why not just put a little bit of my capital into Rob Fannon’s biotech stocks? They’re up 39%, on average and unannualized.

Under our editorial guidelines, I am allowed to invest in the recommendations of our writers (and my own), as long as I wait a suitable length of time (24 hours after a recommendation is published online or 72 hours after a recommendation is mailed out). And often enough, our recommendations are available at attractive prices after a few days. From time to time, I do buy short-term investments based on our analysts work – I’d be crazy not to.

But I’ve learned something about long-term investing after 10 years in this business. It’s hard to beat.

Consider Buffett’s famous purchase of Coke stock, in 1988.

As my colleague, Tom Dyson, noted in a recent DailyWealth column, Coke wasn’t a cheap stock back then. Its share price had gone up every single year between 1980 and 1988. And in the five years prior to Buffett’s purchase, the stock price went up 18% per year, on average – even after you factor in the crash of 1987.

But… using a little-understood accounting secret… Buffett knew that Coke shares would be an outstanding long-term investment.

Between 1989 and 1999, Coke’s market cap rose nearly 12-fold. Even more importantly, the company raised its dividend consistently each year. In 2006, Coke paid out $1.24 in dividends. Adjusted for splits and dividends already paid, Buffett paid $3.75 per share for his stock in 1988. Thus, Coke’s annual dividend, 19 years later, now equals 33% of his total purchase price. Today, Buffett is earning market-beating results on his original investment with dividends alone.

Before you say, "Oh, I’m too old for that approach. I don’t have enough time left for long-term investing," you should know that Buffett was 58 years old when he put $1 billion in Coke stock. You should also know that the investment represented 35% of his equity portfolio. He was putting most of his chips into one basket – for the long term.

Early investors in Buffett’s partnership, assuming they held onto their Berkshire shares following the fold-up of the partnership in 1969, have seen each $10,000 invested turn into more than $366 million.

Looking at these facts, I conclude the obvious: Einstein was right about compounding returns. Assuming you can find the right kind of business, trading at a fair price, everyone should have at least 20%-30% of their savings locked up in long-term investments.

What’s the right kind of business?

Over the holiday, I went back and read almost all of Warren Buffett’s annual reports. I was searching for his secret. How does Buffett know, years in advance, whether any particular business will prove to be a great long-term investment?

The answer was in his 1993 annual report.

"At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own and the personal characteristics of managers with whom we wish to associate…"

What economic characteristics?

"Is it really so difficult to conclude that Coca-Cola and Gillette possess far less business risk over the long term than, say, any computer company or retailer? Worldwide, Coke sells about 44% of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market. Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power… The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles."

I wasn’t satisfied with merely having the idea of an economic "moat." I wanted to know how Buffett quantified that moat and how he valued it.

I found the answer in his 1983 annual report, where he discusses the importance of economic goodwill – a difficult accounting concept to grasp, but one that’s based in excess returns on assets. In short, the secret is buying companies that can produce very large returns on net tangible assets without large annual capital expediters.

What’s my proof? Let’s look at large Berkshire purchases – starting with the most well known, Coke.

On $12 billion in net tangible assets, Coke earns nearly $5 billion per year. That’s a 41.6% return on net tangible assets. Imagine a mutual fund that could earn that high a return, year after year.

A more recent Berkshire purchase, Anheuser Busch, has even more impressive numbers. BUD has roughly $2 billion in net tangle assets and earned $1.8 billion last year – a 90% return on net tangible assets.

The most recent large addition to the Berkshire portfolio – Johnson & Johnson – has around $35 billion in net tangible assets. It earned $10.4 billion last year, a 29.7% return on net tangle assets.

All of these companies have proven – over many years – that they are able to grow their sales and earnings without making large increases to capital investments. In short, these companies are all very capital efficient.

For example, 10 years ago, J&J produced $21.6 billion in revenue. It spent $1.3 billion in capital investments. It produced a 15% return on assets and paid a $0.37 dividend to shareholders. Last year, in 2006, J&J spent $2.6 billion on capital projects, an increase of 91% from 1996. Revenues, however, grew by 133% over those 10 years. Dividends grew by 243% – not counting the more than $1 billion share buyback last year. Return on assets was up to 18.7%. Every penny the company spent on building its business led to higher sales, higher profits, and, most tellingly, higher dividends.

Buffett’s secret – the secret to long-term investing – is to buy companies that have outrageously high returns on net tangible assets and that have management teams that are committed to returning excess capital to shareholders.

Are there more companies like this available today? Yes. They’re rare, but you can find them if you look.

The one I picked for my subscribers today is a quintessential Buffett opportunity…

It owns an iconic American brand in a business that’s been almost totally unchanged in 100 years. It dominates the business, with almost 50% of the market. It has been the market-share leader every year for the last 18 years. Its nearest competitor has a puny and shrinking market share of only 16%. Its customers are fiercely loyal – repeat customers represent 51% of the buyers of its core product. It’s fair to say that this company’s customers nearly worship its product.

The company’s financial reports support the apparent economics.

Last year, with less than $3 billion in tangible assets, this company produced more than $5 billion in revenue and earned nearly $1 billion. The company’s return on net tangible assets is an astounding 34.2% In the last 10 years, it has increased its dividend by 1,100% – not including the $1 billion share buyback it has conducted in each of the last two years.

This incredible growth was financed on a shoestring. In 10 years, the company’s annual capital expenditure budget has only increased by 10%.

This is one of the best long-term investments available on the stock market today. Investors should expect to see 500%-1,000% returns on their capital over the next 10 years. Surprisingly, the stock is trading at a price Buffett himself says is very attractive.

If Buffett doesn’t buy this company soon… people might say he’s lost his touch.

Regards,

Porter Stansberry

Cockeysville, Maryland

January 5, 2007

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