Mental models

Multidisciplinary approach to thinking – speech by Peter Kaufman

I would like to thank my good friend Peter Phan for sharing this excellent talk. Peter Kaufman is a successful entrepreneur who has studied and learnt Charlie Munger’s method of using the “big ideas” from various fields to solve real life problems. I found this speech to be very illustrative of the multidisciplinary approach. Sometimes when Charlie talks about this, it can be quite hard to understand as he doesn’t always give real life examples.

Although the talk is a bit long at 45 minutes it is jam packed with wisdom not only about investing but how to live a happy life, so it’s well worth listening to.


Steamships Trading

Steamships Trading

As opposed to my usual assortment of cheap low quality companies, Steamships (ticker: SST) is a high quality business currently trading below the market value of net assets with incoming strong tailwinds.

Steamships has a long history operating in PNG, this year marks its 100th anniversary. Its controlling shareholder, Swire group (72% interest) of the UK, was founded in 1816. A company that survives and thrives for 100 years is a rare breed and I believe testament to its management and culture.

My thesis for Steamships is predominantly a play on liquid natural gas (LNG).

Steamships has three main divisions as categorised in the annual report:

  1. Logistics (FY17 – 46% of consolidated revenue).This division has three businesses. Consort lines is the largest operator of coastal shipping in PNG with 16 vessels. Pacific Towing is the leading provider of harbour towing and mooring services, operates 11 tugs and 10 associate vessels in 5 ports across PNG. East West Transport is one of the main multifaceted transport and logistics operator and JV Port Services – which is a collection of joint ventures that provides a full range of stevedoring and handling facilities across many ports in PNG.
  2. Hotels & Property (FY17 – 32% of consolidated revenue)Coral Hotels with seven hotels (546 rooms) and apartment complexes (129 apartments) is the largest hotel group in PNG. Pacific Palm Properties (PPP) is one of the largest real estate landlords and property developer in PNG. PPP’s business model is to develop strategically located commercial and industrial properties for yield and long term property appreciation.
  3. Commercial (FY17 – 21% of consolidated revenue)Laga Industries is one of PNG’s largest consumer good business manufacturing and distributing ice cream (Gala ice cream – No. 1 ice cream brand in PNG), vegetable oil, condiments, powdered milk, snack food and beverages. SST also has a 50:50 joint venture with Colgate Palmolive to market and distribute Colgate’s oral, personal and home and fabric care products in PNG.

SST has many leading businesses in logistics, hospitality and consumer products in PNG and therefore its fortunes are highly correlated with the overall PNG economy.

Why do I like it?

There are two main reasons why I think SST is a good bet. The first is its current market capitalisation is backed by property. The second is that I believe earnings are set to double in the next 3-5 years.

As I write this post, SST is trading at a $18.50 a share which gives it an enterprise value of A$710 million or kina $1.78 billion (exchange rate of A$1:K$2.50).

Enterprise value backed solely by the property portfolio

The FY2017 annual report shows the range of market values of its property portfolio:

Investment properties are properties that are leased out and are mostly industrial and commercial properties. Other properties are real estate that are used by the businesses and includes hotel premises, offices and warehouses.

Based on say the mid-point value for the properties (k$1.8 billion), it appears that the market is only appreciating the value of the property portfolio and essentially assigning no value to the logistic and commercial businesses (which represents more than half of the consolidated revenue).

I have no reason to suspect that the reported property values are overstated. I based this opinion on reviewing 1) the rental yields and 2) comparing the growth in reported market values to net book value of the investment properties over a 10 year period.

The chart below shows the rental yields achieved for the investment properties over the past 5 years.

Yes, one can only dream of getting such yields for commercial properties in Sydney or Melbourne. Based on my understanding the above yields are consistent with the market in PNG. Therefore from the rental yield perspective, the reported market values for the investment property do not appear to be bullish. Note that FY2017 rental fell due to a fall in occupancy from 90% in the prior year to 80% in FY2017.

As PPP business model is to develop new properties to lease, I’ve also reviewed the growth in the property portfolio’s net book value (NBV) and reported market value (MV) over the past 10 years. The chart compares the growth in NBV and MV from 2008 to 2017.

The chart shows that the growth in NBV exceeded the growth in MV and that management has not increased the MV since 2013. This suggests that additions to existing property and/or new developments are the main drivers of growth as opposed to revaluation gains.

In this regard, I am quietly confident that the reported market values may even be conservative.

But plenty of conglomerates trade for less than the sum-of-their parts…

Yes, it’s true that many conglomerates trade at a discount to their sum-of-the-parts values. However, in SST’s case I believe there is also a clear earnings catalyst in the next 3-5 years which is likely to double its current earnings.

Let’s take a look at its past earnings and focus on SST’s underlying profits.

Underlying profit more than doubled between 2008 and 2012. The reason? PNG LNG. The PNG LNG project led by ExxonMobil was PNG’s first mega LNG project. Construction of the project began in 2010 when the size of the PNG economy was US$11.6 billion (source: Worldbank). It took four year and US$19 billion to complete the project. Given the size of the project relative to PNG’s economy at that time, the economy doubled from 2010 to 2014 during the project construction period. You can watch this video to understand the scale of this project.

SST benefited from the hive of activity during the construction period with both the hotel and logistics divisions enjoying high utilisation rates. Hotels and apartment rentals did well with the expatriate workers flying in and out of Port Moresby and the logistics division was busy with high levels of cargo and equipment being transported.

Isn’t that history?

PNG is endowed with gas fields which have low extraction cost. For example, the chart below shows the breakeven cost for PNG LNG project being lower than any Canadian or Australian gas project.

The PNG LNG has performed well since commencing operations and has consistently operated above its name plate facility of 6.9 million tonne p.a. (MTPA). So much so that its owners have recently agreed to expand the PNG LNG project which will see it doubling its output to 16 MTPA at a cost of US$13 billion (see Reuters’ report).

Part of this expansion also involves the development of another large gas field called Papua LNG (Elk-Antelope gas field) which is led by Total S.A. The gas resource for Papua LNG is 6.5tcf as compared with PNG LNG of 9tcf (prior to the recent upgrade).

All up, the owners plans to add three more LNG trains, with two underpinned by gas from Elk-Antelope and one underpinned by existing fields and a new P’nyang field operated by Exxon. The map below illustrates the location of these gas fields.

The expansion will result in a total LNG annual output of 16MTPA, slightly larger than Gorgon and equivalent to the North West Shelf in Australia. Asian LNG prices looked to have recovered from their 2016 lows which should provide good incentive for these projects to move ahead.

Once these projects kick-off (in the next 3-5 years), Steamships is well positioned to reap the benefits from its hospitality and logistics divisions and I foresee that profits can exceed the record underlying profit achieved in 2012.

In addition, the following large resource projects in PNG’s pipeline will also benefit Steamships if developed:

  • Wafi-Golpu: Newcrest and Harmony JV copper-gold mine estimated to contain 20m oz of gold and 9.4m tonnes of copper.
  • Frieda River: Copper-gold mine estimated to contain 19m oz gold and 12m tonnes of copper. This project is led by Guangdong Rising Asset Management, a Chinese state owned enterprise.

Other reasons I like Steamships:

Good professional management

I like Steamships’ management as they have been performed well and taken care of shareholder’s interest. For example, the company has not raised equity capital nor issued a single ordinary share going back as far as I can check to 2002, over the past 14 years Steamships has managed to pay a dividend every year and grew its net asset/ equity at a compound annual grow rate of 11%.

Bear in mind that the property assets make up a large proportion of assets and that the above growth rate is based on book value and not market value. Current market value of the properties is circa k$1 billion (based on the average of the market value range) above the book value so using the market value would result in the net asset’s growth rate exceeding 11%.

Growing property portfolio

Assuming that none of the resource projects get off the ground (which is extremely unlikely), the property development business should still be a value driver. Over the past 10 years the NBV of the property asset has grown by a CAGR of 13.4% (refer to above chart on growth in real estate’s NBV and MV). I understand that the company still has vacant land in good locations to develop.

The property portfolio represents by far the biggest fixed assets on the balance sheet. Out of a total of k$1,168 million of fixed assets in FY2017, the property assets make up k$736 million or 63% of the total value.

Why is Mr. Market undervaluing Steamships?

I think the first reason is the perceived economic risk of operating in PNG. The PNG government has been running a budget deficit for the last few years and government debt has currently increased to circa 30% of GDP (source: PWC PNG 2017 budget report). A current shortage of foreign currency is also causing significant economic problems for PNG’s economy which has arguably been in recession since 2015.

The budget deficit was caused by a significant overestimation of tax revenues from the PNG LNG project by the government. Tax revenues fell short because of subsequent collapse in LNG prices compounded with the generous concessions given by the government. One example of this is that the royalty payments are calculated based on a “well-head value” which allowed for deductions on repayments of the US$19 billion project loan, capital allowance and operating costs. Other tax concessions include a 10 year depreciation allowance, GST exemptions etc, royalties treated as advance payment of income tax. For more information, please refer to this Worldbank report on PNG.

Although the forecast revenue is currently falling short, as the loan and assets are amortised, more and more revenue should flow to the government. So I believe this shortfall in tax revenue to be temporary. Once material tax revenue starts rolling-in, this should alleviate the budget deficits. To give an idea of the size of the potential tax revenue, the 2013 national budget forecast k$2 billion in revenue to the government from this project. This would represent 17% of PNG government’s revenue in FY17.

The second is reason is well its PNG so there is a perception that it could end up a failed state ala Somalia/Yemen/Zimbabwe . I think that the chances of PNG blowing up like those countries is low for four reasons: 1) PNG’s society is very fragmented with more than 800 tribes; there are currently 20 political parties in parliament with the leading party only winning 27 out of the 111 parliamentary seats (not enough to form government). In fact no one party in PNG’s history has ever won enough seats to form government. Therefore I believe it is unlikely that a strongman leader will emerge that can maintain support amongst all the various groups long enough to ruin the country. 2) A common denominator of failed states is internal conflicts/ civil wars. Conflicts in PNG tend to be on a much smaller scale (possibly due to more numerous groups) than compared to say civil wars in some failed African or Middle Eastern countries which absolutely decimated those countries. 3) PNG has an independent judiciary; this is a rare among failed states. 4) If things really do go downhill, Australia is unlikely to sit idle as she can’t afford to have a humanitarian crisis at her doorstep.

The third reason is that some economists believe that the kina is 30% overvalued against the US$ even though the kina has devalued by 25% since June 2014.  This may be true but I believe once the project revenue starts flowing and coupled with the new LNG projects, the currency should strengthen considerably over the longer term. At the same time the foreign currency shortage would also be resolved.

The fourth reason is that the stock has very low levels of liquidity and zero institutional following.


I believe this is a quality company currently trading below the market value of its net assets. The stock price is currently depressed due to the poor economic conditions currently being experienced in PNG that is affecting its earnings. However, Steamships’ earnings is likely to get a huge boost from the LNG projects coming on stream in the next 3-5 years given its leading positions in hospitality and logistics. This should see the stock exceed its high of $40 set in June 2014.


Regional Express

Regional Express – 1HY18 results

Click here to see my original post on Rex.

It was a solid half year result for Rex. No surprises and my views are pretty much the same as my last post. A few points to highlight:

  1. The passenger and load factor increases were the main driver of the 60% increase in profit before tax. An illustration of this is the cost comparison between the prior comparable period (pcp). Total cost for 1HY18 only increased by $1.5 million from the pcp, whereas passenger revenue increased by $5.4 million.
  2. Based on seven months of operating statistics, it appears that after many many years of decreasing passenger numbers and load factors, there is a recovery underway.
  3. There is some seasonality in the business, the first half tends to be marginally more than the second half. The split is around 52:48, so I expect the second half results to fall marginally short of the first half.
  4. I see the new RPT win in WA being marginal. The Perth to Carnarvon and Monkey Mia route has  combined annual passengers of less than 30,000. Perth to Albany and Esperance has combined passengers of 100,000 pa. These two new routes will still be helpful in defraying some of the fixed cost base at Perth.

In terms of outlook, management has flagged a 20% improvement in the full year result. These guys are pretty conservative so that number probably has a bit of buffer in it. Factors that may further improve the FY18 results include more charter revenue wins from an improving outlook in commodities (coal and copper), depreciation in the USD:AUD exchange rate leading to cheaper spare parts and possibly even fuel cost.


Capral FY2017 results

See my original post on Capral here.

The floor didn’t cave in and the stock price went higher. When I wrote my original post, my opinion was that the market at that time was pricing in a bad result for FY2017. Turns out, the FY2017 result was actually pretty decent.

FY2017 results were pretty similar to FY2016’s results so there isn’t anything major to highlight. It was pretty much business as usual. Some notable developments include:

  • Normalised net profit (normalised for inventory revaluations) was down 12.7%, this was mainly due to aluminium metal price rising in 2017.  Half of the sales volume is derived from sales contracts with LME aluminium pricing and there is a time lag between the spot price is when the price is charge to the customer.  As LME metal prices rose throughout 2017, Capral’s were unable to fully pass on the metal cost to the customer and therefore margin fell. However, when LME metal price falls, the opposite will happen.

  • Housing starts are slowing with multi residential market falling by 9% and detached units falling by 2%. Capral’s main market is detached housing, so this slight fall has marginally affected sales volumes. The latest HIA reports forecast slowing housing starts for NSW and Victoria in FY2018/19 with the multi residential market falling significantly more than detached housing.
  • Capral sales to the industrial sector have offset the decline in the housing market. Strong demand for truck trailers (e.g. Maxitrans), marine (e.g. Austral) and other infrastructure projects have contributed to a 4.2% increase in revenue (excl scrap revenue) in FY2017.
  • Capral flagged higher capex at the AGM in March 2017 and capex increased by 41% to $5.8 million in FY2017. Capex is expected to further increase to $10 million in FY2018. Capral is introducing more automation in its factories which will further reduce operating costs.
  • New anti-dumping cases have been launched against two of China’s largest aluminium extrusion importers into Australia. I understand that the anti-dumping commission has used a more advantageous cost formula to calculate a “fair price” for the extrusion products which should increase the dumping duties.

At the time of writing, the share price is 17 cents which imply a market capitalisation of $80.7 million.

Based on the current update, I don’t see any reasons why the dividends cannot be sustained as the payout ratio is at 50% and the company has cash of $34 million. I continue to hold this stock.

Schaffer Corporation

Schaffer – cracker 1HY18 result

See my original post on SFC here.

Howe Leather

Howe Leather hit the ball out of the park with it’s 1HY18 result. The biggest surprise to me was the improvement in earnings margin. To illustrate how big an improvement this was, the table below compares my estimate of the 1HY18 EBIT margin to historical EBIT margins.

Management attributed the strong margins to an appreciating EUR:USD exchange rate as 60% of their variable cost are denominated in USD. Based on historical exchanges rates, I compared the change in average EUR:USD and the prevailing EBIT margins for various periods.

If EUR:USD continue at these levels till the end of the FY18, I won’t be surprised if 2HY18 EBIT margins exceed 20%. Current EUR:USD levels are still below average levels if compared to the past 10 years. EUR:USD maybe back on an uptrend since the decline in 2014.

Revenue for 1HY18 was $105 million and management announced that “steady state” volumes have been achieved. The company looks set to easily beat my previous revenue forecast of $180 million for the full year. Although management has indicated the expected revenue for Howe Leather in 2HY18 to be similar to 1HY18, I noticed that since 2015, there has been a seasonality factor which wasn’t previous present; see table below:

If this seasonality pattern continues in 2HY18, a combination of this seasonality factor with the current EUR:USD exchange rate would an even better result in 2HY18.

Building materials

In my opinion, management achieved a good price for the Limestone quarry assets and Urbanstone business; which were not making money. The selling price was approximately 1.5x of the net asset value.

Property division

Not much material change on this front except that the company has gotten state approval for rezoning of the Jandakot property. The next step is getting a local development plan. The Jandakot property development will be a few more years in the making.

SFC Capital

The company announced the formation of a new division to invest the cash generated from Howe Leather. I’ll wait till we get better clarity on how the capital is being invested before giving my opinion on this.

This has been a stellar report by SFC and the share price has acted accordingly by rising to a 12 year high. In many ways, you could have predicted the strong results due to:

  • Management guidance during the mid November AGM for further increase in volumes and profitability in 1HY18
  • The Chairman then proceeding to buying $1.37 million worth of shares two weeks after the AGM. An important lesson here!

Bottom line

I still think the company is undervalued. At Howe’s current volumes and profitability, the market capitalisation of $172 million still only mostly represents the value of Howe Leather. There is value upside from 1) revaluation of the Jandakot property to recognise conversion to industrial use, 2) future cyclical upturn in construction 3) development of the North Coogee and Jandakot sites.



Another cuppa, moms and dads?

I was inspired to write this post after reading a recent article in the SMH by Noel Whittaker.

Cappuccino or latte (cafe latte) is about $3.50 in Sydney. Can you build a nest egg just by forgoing one cuppa a day? You bet.

As a parent with a young toddler, I believe starting an early savings plan for my child is an exceptional idea. With a long runway, not only can kids fully harness the power of compounding but the savings plan can teach them the benefits of delayed gratification/ savings.

The idea is to start a retirement plan the day your bundle of joy is born.

The investment horizon is 65 years (that’s sort of the average retirement age) and the fund would be invested in shares. Shares do not only produce very good long term returns (history has shown that these returns are anywhere between 6%-9%), they can also be bought with relatively small sums of money (as opposed to real estate or commodities), brokerage is cheap and they have zero maintenance cost.

A low cost ASX 200 ETF will be a reasonable way to accessing these returns.

If you start an investment plan which invests $3.50 a day (I would recommend investing into the market on an annual basis to avoid paying too much brokerage fees) for your child and assuming an annual compound return of 8%; the nominal value of the plan at the end of Year 65 would be $2.55 million (before brokerage fees and fund management costs). Assuming a 2% long run inflation rate, this would be equivalent to $704,909 in today’s dollars, not too shabby for just one latte a day huh.

I would argue that after seeing such wonderful results, your child would probably be eager to contribute much more than $3.50 a day when he/ she enters the workforce.

I’ve included the math in the table below. Like me, if you start the plan when your child is older than zero, then just subtract his/ her age from year 65 and take the value from that corresponding year.

The table below shows a combination of daily savings rate (from $1 to $10) and long run annual return (6% – 10%) and the resulting balance (nominal dollars) at the end of Year 65.


Read here for the Noel’s article. If you read his article, I suspect the difference between his figures and mine are due to different compounding frequencies.

This post gives me some motivation to update the ASX All Ordinaries long run return, originally posted here.


Bitcoin, fool’s gold

Looking back at 2017, I think the biggest financial news for the year was bitcoin’s meteoric rise from $964 on 1 Jan 2017 to a high of $19,100 on 18 Dec, a return of 1,884% in less than 12 months. After hitting the highs, its price has fallen and is currently trading at $14,000. Its volatility is not for the faint hearted.

Bitcoin started life as an alternative currency with the advantages of 1) not requiring an intermediary to make transactions and 2) free of government’s regulation. However, as its rise caught the attention of the masses, pundits started calling it the new gold.

That statement got me thinking, what makes gold valuable? So I dug around the internet to find out.

Base metals such as copper or iron derive their value from their industrial demand. Almost all of the base metals extracted are put to industrial use. Compared to the base metals, the industrial demand for gold only takes up 12% of its annual supply and yet gold is far more valuable than the base metals. For example, at current prices, a tonne of copper is worth US$7,018 and a tonne of gold is worth US$41.2 million.

To understand why gold is valuable, we have to go back to early human civilisation during the early days of coins. Gold is valuable due to its chemistry. In the early days, gold’s properties made it an ideal choice of metal to be forged into coins.

  • A currency needs stability and gold is relatively scarce and its supply steady. It is much more scarce than iron or copper but more abundant than some of the platinum group metals. Coins would have to be much smaller with more limited supply if they were made from palladium.
  • Compared with other metals, gold has a relatively low melting point (1,000c) which made it easier for ancient man to extract and smelt as compared to say aluminium, which is much harder to extract and has a melting point of 2,000c. Ancient man just didn’t have the specialist equipment to smelt metals that had high melting points.
  • Gold is “beautiful” and is non-reactive to air and water. A gold coin casted today will look pretty much the same a thousand years from now. Iron rusts, copper turns green and even silver tarnishes, gold however stays the same.

Man’s infatuation with gold has existed for at least 5,000 years if not more, its value is ingrained into our psyche and culture. Bitcoin on the other hand, has only existed since 2009.

So do I think Bitcoin is the new gold? Absolutely not.

I believe Bitcoin is in bubble territory because its current value is not supported by anything other than pure speculation. As an asset it does not generate any cash flow (so it’s nearly impossible to value) and as a form of currency, its volatility makes it undesirable. Therefore, it serves no utility for the vast majority of society.

However, I believe Bitcoin will be worth something due to its underlying demand from vice activities. Bitcoin being decentralised and anonymous is perfect for money laundering activities.

Have a happy new year and prosperous 2018!

Schaffer Corporation

Schaffer Corporation – things are looking up

Schaffer’s share price is on a roll. The share price surpassed the $10 mark this week on two very positive announcements.

The first positive announcement is that Schaffer recently received town planning approval for increasing the development size of their Jandakot property from 12 hectares to 39 hectares (or 390,000 square meters) for future industrial developments. Any future development will still be subject to various planning, environmental and infrastructure approvals. However, given comparable industrial land values of $200 per square meter, this is very positive news.

The second favourable news is that John Schaffer recently purchased 140,000 shares on-market at an average price of $9.80 per share. This is a cool $1.37 million endorsement from the Chairman.

In my opinion, there maybe a risk that the share price may pull back after rallying nearly 100% over the last 12 month (I don’t know and don’t speculate on short term share price movements). However, in the medium to long term, I believe there is more upside due to the increasing volumes and margins at Howe and potential multi-million property developments at North Coogee and the Jandakot properties.

Musings Regional Express

Unexplained volatility

I’ve owned Regional Express’ (REX) for a while now and lately I’ve noticed that the share price movements have been more volatile than usual. After yesterday’s massive 11.3% gain, I wanted to see whether the recent share price volatility made any sense.

In terms of significant announcements made by the company; the FY17 financial results, final dividend for FY17 and profit before tax (PBT) growth forecast for FY18 were announced on 28 August 2017. At the AGM yesterday, management gave an update for the FY18 PBT growth forecast. Between 28 Aug and 22 Nov there were no significant announcements and the ex-dividend date was 23 Oct 2017.

Rather than chart the share price, I have charted the company’s market capitalisation over the last 37 days to give a better perspective of the swings in the company’s value.  There were four big moves over this period which I will foolishly attempt to rationalise. The aggregate value (whether up or down) of these big movements was $89.2 million (on a sub $200 million market capitalisation company). Now over the same period, the ASX 200 went up 4% and market volatility was not remarkable (the biggest market moves were up 1%), so this suggests that the four big moves were not influenced by the general market.

The first big move increased the company’s value by $28.6 million (18.3%) over twelve trading days. Prior to this move, the market had a month to absorb the FY17 results and FY18 profit forecast announced at the end of August 2017. I’m speculating here but it appears to me that there was a rush to buy the stock before the ex-dividend date. However, this also doesn’t quite make sense to me as market participants had ample to buy the shares and the total dividend being paid out was only $11 million (10 cents per share) fully franked; far less than the $28.6 million being added to the company’s value.

The second big move resulted in a single day fall in the company’s value of $19.8 million. As Rex went ex-dividend on this date, a fall equivalent to the value of the dividend is expected. Typically, this happens due to investors competing away an arbitrage opportunity where an investor can buy shares before the ex-dividend date, sell it the next day, collect the dividend and make a profit. Rex’s dividend payout was $11.0 million (10 cents per share) which was fully franked or equivalent to $15.7 million (14.3 cents per share) grossed up. The market fell by $19.8 million exceeding both the cash value and the grossed up value of the dividend. So the dividend arbitrage strategy actually lost money here?

The third big move caused a drop in company value of $23.1 million (-13.6%) in six trading days. Over this period, the general market was flat and the only announcement by the company was an AGM date announcement. I don’t even know where to start in trying to explain this.

The fourth big move was a one day increase in market capitalisation of $17.6 million (11.3%). The AGM was held on the day and management’s  presentation showed that growth in FY18 PBT was expected to be over 20%, which was an improvement on their previous mid-teen PBT growth forecast. Using 15% as a proxy for “mid-teen”, I did some calculations to find out whether this huge movement could be explained by a 5% (20% vs 15%) uplift in FY18’s PBT. My calculations show that the difference between 15% and 20% growth in PBT is $890k. Even if I applied a 10x multiple to capitalise this PBT uplift, it would only result in a company value uplift of $8.9 million, far less than the observed market capitalisation increase of $17.6 million.

These large movements in share price are not uncommon especially outside the ASX 100 companies. It shows market psychology and momentum factors are powerful short term drivers of share price. If you are investing on a fundamental basis, it is hard to make any sense or logic for these massive moves in company value. So ….. I think the efficient market purists must also believe in the tooth fairy.

Warren Buffett

An easy billion

I recently read Warren Buffett’s Ground Rules by Jeremy Miller. I would recommend the book to anyone interested in Warren Buffett’s pre-Berkshire days when he was starting out his various investment partnerships, which were eventually consolidated into a single partnership called Buffett Partnership Limited (BPL). What I found impressive was Warren’s clarity of thought and honesty to his early investors at such a young age. His approach to investing today is essentially the same as it was towards the end of the BPL days. The difference is that the size of his funds today limits his universe of potential investments which explains why he buys Apple today and not Blue Chip Stamps.

Warren’s investment returns over 12 years is highlighted in the book and when he liquidated BPL in 1969, he distributed cash and Berkshire Hathaway shares to its members. So that got me thinking, how much would his early investors made if they invested $10,000 in the partnership in 1957 and invested all the proceeds from BPL’s liquidation (and continued holding Berkshire shares which were also distributed) into Berkshire Hathaway in 1969 and held the stock through to 2016?

Note: The pre-1969 returns are taken from Warren Buffett’s Ground Rules. The post-1969 returns are share price returns of Berkshire Hathaway taken from the 2016 annual report.

$1.6 billion is the answer.

$10,000 turned into $1.6 billion due to Warren’s ability to generate an annual compounded return of 22% per year over 60 years. This ability to consistency produce market beating returns is why the “Oracle of Omaha” is such a legendary investor.

Although I wasn’t fortunate enough to cross path with Warren, the key lessons I take away are:

  • To unleash the powers of compounding, you need two ingredients; the ability to consistently generate good returns and a long runway of time. This is shown in the chart above, where the line starts ascending rapidly from the mid 1990s onwards.
  • If you find a compounding machine, don’t sell!

So how many people actually stayed invested with Warren from the early days? According to Forbes in an article called “The Berkshire Bunch”, there are at least 30 families in Omaha who are centimillionaires from owning Berkshire stock. Other than being born into wealth or striking the lottery, I reckon these early investors made one of the easiest fortunes ever made.