“Microeconomics is what you do, macroeconomics is what you put up with”

by Travis Johnson, Stock Gumshoe | April 30, 2016 7:50 pm

First quick reaction to the Berkshire annual meeting

That headline is a quote from Charlie Munger from today’s Annual Meeting for Berkshire Hathaway (BRK.B) here in Omaha, and it’s one of the ones that really caught my ear.

He was responding to a question about how he and Buffett avoid making big predictive calls about the economy, or assessing the near-term health of the economy based on the results of Berkshire Hathaway’s 60+ operating subsidiaries…. and, essentially, how they avoid falling prey to the psychological mistakes and hubris that hamper most of us when it comes to investing.

It might be that no executive is better prepared to predict what will happen with the US economy than Warren Buffett, but he steadfastly says that he doesn’t do that because he’s terrible at it.

And if Buffett is terrible at it, with time to do nothing but think deeply about businesses, and with monthly reports on his desk from subsidiaries that tell him exactly what’s happening with railroads, and real estate, and manufacturing, and restaurants, and a dozen other sectors of the economy… what the heck are we doing listening to anyone who predicts what the economy is going to do over the next year? And doubly, what the heck are we doing investing based on some sort of prediction about where we “feel” the economy is headed?

Microeconomics, in this case, is the study of businesses and simpler economic relationships… like what you would do if you were trying to assess whether there’s a market in your town for the Dairy Queen franchise you’re planning to open, or arguing with your kids about how much allowance they need. It’s the study of simpler economic relationships. Macroeconomics is the study of larger economic systems — in this context, macroeconomic forecasting would perhaps be predicting what US GDP will be, and where the Eurozone will end up, and what will happen with gold. Since economics inextricably involves human behavior it’s all hard to predict, but macroeconomic forecasting is nearly impossible. Even the Federal Reserve, the most connected and learned army of economists around, gets their forecasts quite substantially wrong most of the time.

That’s a lesson we would all do well to remember — stop trying to think you will ever know what’s going to happen with the economy, or with global trade changes: Think about things you can understand, and maybe understand better than some other people. You and I can’t add anything by saying “I think Germany’s about to turn around”… but maybe we can add something by saying “the world probably isn’t going to end, and I’ve found a German company that has excellent margins and steady revenues and reliable management, and is in a solid business that will probably exist for 50 years.”

I haven’t found (or specifically sought) such a company, by the way — that’s just an example.

As Munger said a bit later on, “you don’t have to be smart, just be averse to the standard stupidities” … and if you add to that some control of your emotions, and the ability to ignore things that aren’t in your personal strike zone, well, you’re much closer to being on the same playing field as Munger and Buffett.

I’ll have much more to share in the days ahead as I work through my notes from the value investing conference I attended before the Annual Meeting, and I have quite a few “red hot” teaser picks to catch up on for you and some thinking to do about a couple companies I own that have been generating news lately (like Apple and Grenville Strategic Royalty)… but for now I’ll close it out by updating you on a few things I did do in my portfolio to close out the week:

Given the recent rise in gold, and the fact that substantial portions of my gold “bets” are time-sensitive (options or warrants, so they have expiration dates), I took a bunch of profits off the table in some gold positions that had more than doubled — that includes overly promoted stocks like First Mining Finance (FF.V, I sold about 40% of my position) and Brazil Resources (I sold half of my warrants), as well as my Sandstorm Gold (SAND) options.

I continue to have exposure to all three of those, and to gold more broadly (including physical gold as well as the mining ETFs) but selling a substantial portion after those equities roughly doubled in a few months takes some risk off the table for me by essentially reducing my gold cost basis to near zero. I still want to have exposure to gold, but I don’t want to keep outsized bets in play that depend on gold being at a certain price over just the next three to six months (or year, even) — those holdings just got too big for my portfolio.

And what did I do with some of that cash? Well, as has become routine now when annual meeting time rolls around and I look closely at Berkshire’s valuation, I added a little bit more to my Berkshire Hathaway (BRK.B) holdings.

Berkshire is not trading at bargain prices, but is roughly as cheap now as it was the last time I added a little bit to that position last month[1], about 1.35x book value, and we have only the loose numbers about the first quarter to go from (their full earnings release, including the book value for March 31, will come out next weekend, but Buffett provided the basic numbers at the meeting). From the numbers Buffett released, it will likely be a strong quarter on the headline numbers partly because they registered a gain from the close of their Duracell deal (they essentially exchanged their Procter and Gamble shares for full control of Duracell), but their real operating earnings dropped from a year ago, largely due to the weakness at their railroad. Earnings power has also increased with acquisitions (like Precision Cast Parts, which closed during the quarter), and the “intrinsic value” calculations are likely to be quite similar to last month[1], when I pegged them with what I consider a very conservative “intrinsic value” of about $162. That could come down a bit, given the drop at a few of their major stock holdings, but not markedly so.

So it’s still the best-managed and most shareholder-friendly large company in America, and you can buy it at a discount of at least 10-15% to what should be their most conservative “real” value, with the implicit promise that they will buy back shares if the stock drops by more than 10% (Warren continued to reiterate that they will essentially be “all in” buying back stock if it falls to 1.2X book value).

I obviously still like Berkshire as a base holding, the valuation is somewhere between cheap and reasonable using conservative assumptions, and now it’s back to being my largest holding (squeaking a few dollars past facebook), which is fitting because it’s the one I am most comfortable with for the long term in almost any economic environment. The largest risk to Berkshire over the long run remains the possible loss of corporate culture and acquisition process (and acumen) when Buffett retires or passes from this mortal coil, but they’re going to keep generating massive amounts of cash, absent a substantial recession in the US or a horriffic 9/11-scale insured catastrophe, under any management team… and the partnership may keep going for quite a while. Charlie Munger is 92 to Buffett’s 85, and neither one is going to retire unless their doctors force them. They both still look plenty peppy to me, and they’re sure quicker with a quip than I am.

My third largest personal holding these days, Markel (MKL), is not very likely to get additional capital from me at their current valuation (I still admire Markel and consider it an unusually high quality company, but it’s gotten awfully expensive)… but I could change my tune when I attend the Markel Breakfast tomorrow.

Markel mimics a younger Berkshire in many ways, most of them admirable, and probably is too expensive these days largely because of that “baby Berkshire” comparison, and part of that mimicry includes an annual presentation to MKL shareholders here in Omaha following the Berkshire meeting. They’ll be taking questions from shareholders just like Charlie and Warren do, it’s just that it’s a couple hundred folks in a hotel ballroom instead of 18,000 souls in the arena across the street. I’ll share my thoughts and notes from that as well — maybe even quickly, depending on how the Wifi is on my flight home — and we’ll be back on our regular schedule next week. Thanks for reading!

Endnotes:
  1. last month: http://www.stockgumshoe.com/2016/03/friday-file-more-berkshire-and-some-good-friday-musings-about-bad-performers/

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