Berkshire-esque companies are an interesting corner of the market: Leucadia, Biglari, Loews, Markel, etc. To an extent some of these companies court the comparison while others get lumped into the category by a mixture of value investing, insurance, owner-operators and holding companies. These claims are hard to evaluate in regards to translating into a business that will compound book value at 15-20%. None of the companies have valuation that imply much optimism about their futures, but what exactly would it take to know which would be capable of continuing their past records?
| Company | P/B | BVPS CAGR 12/31/00-12/31/10 |
| Berkshire Hathaway | 1.15 | 9% |
| Biglari Holdings | 1.75 | 3 year record, not useful |
| Leucadia | 0.87 | 16% |
| Loews | 0.85 | 9% |
| Markel | 1.15 | 11% |
Leucadia’s managers look like they are flirting with retirement in the next several years, so it would make little sense to plan on owning the business for 30 years. Biglari Holdings is still mostly in the capital light business of franchising restaurants so the P/B is slightly misleading. It is interesting that there is not much of a valuation premium for any of these businesses otherwise, despite great long term track records and very good relative performance over the past 10 years. A Richmond paper wrote an articlef titled “Markel builds the next Berkshire Hathaway.” To intelligently invest in any of these, the price is clearly important, but how can one evaluate the more abstract claim of possessing Warren Buffett’s ability to compound capital at a high rate over a long period of time?
Is it easier to identify someone else who can compound capital at 15-20% or a business that can compound capital at 15-20%? While the latter is easier to identify, it probably offers lower potential investment returns. Most people recognize businesses that can compound growth at a nice and profitable rate over a long period of time, so their valuations rarely create a buying opportunity. Many of these Berkshire-esque companies currently trade at or below book value, so the valuation hurdle is lower. So my thinking is that some of these may be interesting investments on the grounds that they have a broad mandate of possible actions, the proper judgment to compound book value at a nice mid teens rate and valuations that mean I could purchase the shares and get the same return.
There is an attraction in an open ended business plan. Many companies – like, oh, I don’t know, Netflix? – are a lot like me and don’t know the first thing about capital allocation. There are a lot of bad investment decisions made at corporations based on institutional imperatives, soft market enforced restrictions to focus on “core competencies” and just agent-operators looking to make a quick buck on their options. But if a company’s only goal is to protect capital and compound it, all that nonsense should theoretically be repudiated from the outset.
In a broad statistical sense, the ability to compound book value is easier when it is $100 vs. $1,000 or $100,000. If the capital allocator is capable of identifying the best opportunities for compounding, there is a higher likelihood of identifying the absolute best if the size is irrelevant. So a short time span wouldn’t offer an empirically sound backdrop for identifying someone who could compound 15-20% over 30-40 years. Ideally, the smaller the business is, the lower my mental hurdle for confidence in the ability for the manager to compound book value. At the same time, a manager who could compound a company with $100m in book value to $500m in 10-15 years would clearly be a very capable person, but what if they can’t scale up? So I can’t really claim there is an ideal size.
I don’t think I’ve ever heard anyone really speak unconditionally highly of Sardar Biglari, and a recent WSJ article did a pretty good job marshaling some of the reasons why. According the article, Biglari claims not to court comparisons to Buffett and Berkshire (the article also mentions how the initials of the companies are the same and Biglari and Buffett share the same birthday, but that has nothing to do with anything). At the same time, it is hard to believe he isn’t doing certain things inspired by Buffett and Berkshire. He has a lengthy Q&A based annual meeting. He has a high share price to encourage long-term shareholders. He tried to take over an insurance company, ostensibly for float to invest. The data points don’t completely match for a direct comparison, but there is a narrative arc that is complimentary to Berkshire's.
I don’t think the discontent with his personality or compensation necessarily negates his ability to compound at a high rate. He has a very short record to judge, which is the inherent paradox. I can’t know if he can compound book value at a high clip until at least partially after the fact. This isn’t good enough for me, because most people (anybody?) did not expect Buffett to do what he did with Berkshire circa 1970. I don't think anyone would expect anyone to do that. His earlier years did not consist of the straightforward application of the distilled wisdom and advice he dispenses today. He originally took over Berkshire the textile company based partially on a grudge against the then CEO – not the perfectly rational decision making he is praised for today. So first impressions can be misleading (measured in ~5 year periods). I don’t think the “system” I’m trying to devise has to be able to go back to 1965 and identify Warren Buffett, but it’s necessary to take into consideration where the flaws may be.
The reason I bring up Biglari is that even though he hasn’t really established himself as a superinvestor or anything of that nature, he is young and seems inclined to be one. It will be interesting to see the transition that Berkshire goes through in coming years. I would think that the modern crop of investors who many people probably expect to compound at high rates would rather do so in the comfort of a hedge fund with a handful of investors and less focus on the day-to-day operations of the businesses they partially own. This is partially untrue – David Einhorn has Greenlight Capital Re and Bill Ackman recently raised money for a SPAC. Seth Klarman hasn’t jumped into the arena though and it's not like Todd Combs or Ted Weschler wanted to start their own little holding company.
To track back to the idea that $100 is easier to compound than $1,000, growing from $5bn to $25bn is a lot harder than the journey from $1bn to $5bn (neither are easy) for a number of reasons, if only the fewer potential investments that can support such growth while still receiving a margin of safety. On one hand, it isn’t a mistake that they have the track record they do, but on the other it’s still uncertain that they continue the path. Nobody just loses their ability to identify the opportunities and on the issue of luck, that would mean the person never had the ability. Increasingly, my impression of intelligent investing is that the person is the problem, not the process. Leucadia invests based on the same underlying theory as Berkshire (price is what you pay, value is what you get), but the practice is completely different. There’s a human element on the downside – the companies are hard to own on the premise that there is downside protection in an idiot running the company one day and doing fine.
Maybe it’s my poor imagination, but while the "why" part of the equation is easily answered, the "how" part is not for this type of business. Why? Because an intelligent capital allocator is in charge. How? Because capital is allocated intelligently - but this is circular and abstract. The way that Coke grows is more people are born, more people drink Coke, and they can raise prices every year. Mastercard and Visa need more plastic transactions, which will be driven by higher penetration globally, population growth, and gains relative to paper. I don’t doubt that every single year there is some investment opportunity that offers the identifier 15-20% compound annualized returns over a period of time measured in years. I just have a hard time envisioning it as something that benefits from broader demographic trends or an inherent business characteristic (e.g. Coke is such a low priced product, that a 1-2% price increase doesn’t get noticed like it would on a car). Whatever it is that enables a capital allocator to compound wealth requires judgment, which isn’t exactly something that is telegraphed ahead of time.
If you look at Loews over the past 10 years for example, they have compounded their book value per share at ~10%, absolutely trouncing the S&P. Is the S&P the right benchmark? It's essentially a proxy for the business performance of the US. Since 1960, Loews has compounded BVPS at 15.9% (12/31/60-12/31/10). The recent relative underperformance based on the declining rate of growth shows how the law of large numbers just makes this model of capital allocation difficult over a 50-year period. Loews witnessed management transferred from Larry Tisch to his sons, which is an issue all of these companies face.
They haven’t done poorly, but the results of the past decade aren’t necessarily at a high enough rates to warrant a “next Berkshire Hathaway” type of label. Current management was smart in the acquisitions that created Boardwalk Pipeline, which now contributes a big slug of value to the overall business. They bought 2 pipelines in 2003 and 2004 when they were not popular and combined them to create Boardwalk.
Even though Loews sold off a portion of the shares at a nice profit, they still own a little over 50% of the business plus the 2% general partner interest and class B units, which will convert into regular units in 2013 on 1 for 1 basis. Their regular units in BWP are worth $2.5bn at current prices and Loews paid a total of $2.2bn originally for the pipelines that formed the foundation of BWP. They have another 22.8m Class B units, which will convert in 2 years and would be worth another $600m based on current prices. They also control the GP interest, which entitles them to a portion of the distributions - $26.2m in 2010. This is clearly worth something as well. I wouldn’t be too sad had I been able to make this same kind of investment. The current Tisch generation is clearly not stupid, but is that enough to justify the belief that they will compound book value at a high rate over the next decade?
At the same time, their Highmount deal has yet to prove a huge winner. It may eventually, but it seems like they paid a price that had more optimistic predictions for natural gas prices. The business is primarily natural gas acreage in the Permian basin in Texas. Acreage has been selling for $10,000+/acre and Highmount has leases to 700,000 acres – not worth applying that price to the entire lease, but there is clearly value there. Based on a current book value of $1.4bn and another $1.1bn in debt, the $100m in pretax earnings doesn’t reflect well on the investment returns. They are still in the early stages of drilling wells. Judged over a longer time period, there may very well be profits to justify the investment.
I’m not implying that everything the Loews does has to be a home run. They have pretty consistently hit singles and doubles over the years. They recently invested in a JV with BWP to buy some storage facilities that tie in with the pipelines nicely and put $500m to work. They spun of Lorrilard in a tax efficient way. They seem to be turning around CNA – although I’m no expert on judging that. They finally seem to be spending some money at Diamond after intelligently profiting from the upswing starting in ~2003, but waiting to expand capacity until rig prices came down in the past 2 years. The inaction was intelligent because the long-term outlook for deepwater drilling remains positive, but Diamond’s nominal investment will be lower and returns higher simply as a result of patience. Loews was also in a position to support their partially owned subs in 2008-2009, securing their value and transferring money to the holding company in a tax efficient manner. That said, it doesn't seem intellectually honest to assume that 15.9% long term track record is repeated int he next 10 years. It could happen, but that seems like a scenario that doesn't take into account that they could just as easily continue to underperform relative to that growth.
So obviously, none of this is easy to identify before the fact. There is a much more abstract risk in assuming 1 person will be able to generate the same results as he or she has in the past than assuming 1 business will be able to generate the same results as it has in the past. The intriguing part about buying them close to book value is that investment returns will mirror that of the growth in book value, assuming that’s the performance metric being used.
If you hold any of these types of businesses, how do you get comfortable with their ability to compound in the future? Would you rather just invest in a business at a slightly higher valuation that doesn’t require the skill of an individual?
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