Buffett's Annual Letter Due on Friday

Tomorrow afternoon Berkshire Hathaway is expected to release its 2007 Annual Report, which includes Warren Buffett's annual letter to shareholders. Buffett's annual letter is probably the finest single piece of financial writing produced every year, Buffett is known for his insight and ability to address important issues in a straight forward manner.

Friday afternoon I plan to drop everything to read the letter. I work as a professional analyst and produce a weekly commentary piece, tomorrow that piece will be a series of quotes from Buffett's annual letter. I don't know how financial commentators can do anything else tomorrow. Trying to follow Buffett is like trying to follow Tiger Woods after a golf lesson, what could you possibly say if Woods turned to you and asked "anything you would like to add?". The only reasonable piece of commentary has to be "listen to what he said."

Timothy Burger
contact me at Gmail.com

A Return to Princples?

Today's news provides some clarifying examples of principle in practice:

Economic Development Drives Political Development

Last year 3,786 people died in Chinese mining accidents. As a result of the public outcry over mine safety, the government has shut down some smaller, more dangerous mines and begun to focus on mine safety. As the Chinese people become wealthier they seem to be putting a higher price on human life.

The side effect is that the Chinese are also asking why these mines were allowed to operate for as long as they have. So far the answer seems to be corruption at the local level and a system that has limited checks and balances at the national level. According to the Washington Post there are now calls inside China for an independent judiciary and a more powerful legislature.

As an aside, a focus on safety in all areas of business benefits many of the US firms that manufacture more modern industrial equipment, in mining this means Joy Global and Bucyrus.

Democrats Don't Support Free Trade

In an attempt to woo former Edwards voters and earn the endorsements from key unions, both Clinton and Obama have recently disavowed support for free trade. Their public statements have centered around "fixing" NAFTA to "protect" workers, what that means exactly is unclear.

That promise helped Obama secure the endorsement of the SEIU. Clinton ramped up her rhetoric pledging to eliminate any tax benefits for companies that outsource even a single job.

Investors Are Running, Not Walking, Away From Financial "Innovations"

Today bond insured FGIC began working to split off the firm's business insuring mortgages and other instruments except for municipal bonds.

This is just the most recent example of how structured finance has become radioactive toxic waste of finance. It will be interesting to see how recent volatility in these businesses impacts investment banking, insurance, and academic finance in the near future.

The Weaker Dollar Is Working

In December import prices (even excluding fuel) rose enough to shrink the trade deficit from $63 billion to $58 billion. A weak currency makes it more expensive to buy imports while making our exports more affordable, shrinking the trade deficit. Maybe this is the beginning of the trade balance moving towards, well, balance.

Timothy Burger
E-mail: at Gmail.com

Buffett on the Fed.

Nothing Earth shattering, but this morning Warren Buffett was on CNBC with Becky Quick. She asked about today's Federal Reserve decision and Buffett essentially told her:

We have never bought or sold a stock based on what we thought the Federal Reserve was going to do. We bought Washington Post and it has returned 100 for 1, and I don't think it has anything to do with what the Fed. was doing the day we bought it.

He went on to say that while the Fed. has some impact on currency exchange rates, they are primarily driven by the current account deficit.

While this is stuff I have heard Buffett say a dozen times, it was good to take a minute and recenter myself. It has been a crazy year for investing (they all are) and it has been easy to get caught up in the crisis of the moment, of course one of the reasons that Buffett is a better investor than any of us is that it isn't easy for him to get caught up in the craziness of the moment.

Timothy Burger
timothyb(at)timothyburger.com

CFA Level III Passed

For the past two and a half years I have been in the process of studying for and taking the CFA certification exams. The CFA designation requires candidates to pass three comprehensive exams testing a variety of subjects including accounting and financial statement analysis, economics, asset valuation, portfolio management, and the use of derivatives.

I am pleased to announce that in mid August I found out that I had passed the Level III exam, the final exam required for the CFA designation. Pending approval of my work experience (the CFA institute requires at least 48 months of qualified professional experience), I should be awarded my CFA Charter this fall.

The exam process is very difficult and requires For the June exam, only 40% of the (very smart) people who took the first level exam passed, only 40% of the people taking Level II passed, and only 50% of the people who took Level III (meaning approximately the top 8% of the people who began the process two to three years ago) passed.

Congratulations to everyone else who passed.

Timothy Burger
timothyburger (at) Gmail

Diamond in the Rough

Whitney Tilson mentioned a really interesting article in his latest e-mail. I wanted to make sure you took a look at it.

The Washington Post had Joshua Bell, one of the best violinists in the world, play in a Washington Metro station at rush hour and then discussed the results with various experts. The reaction from people passing by in very interesting,

I thought the thought of one of the curators of the national gallery of art was the most interesting. Essentially he says that if he put most masterpieces in a restaurant instead of a gallery people wouldn't pay attention to them, people need a frame to understand beauty, people have difficulty evaluating things outside of the context they expect to find them in.

For people who work in an industry where people don't think the "five dollar bill on the street" exists, it is interesting to note that only only five or six people out of over a thousand noticed a master playing in their midst, and one of them was a child whose mother moved him on.

http://www.washingtonpost.com/wp-dyn/content/article/2007/04/04/AR2007040401721.html

Timothy Burger
timothyb(at)timothyburger.com

USG Write Up

I recently completed a discount cash flow analysis of USG. Many of you may know that Berkshire Hathaway owns 19% of USG, which was the catalyst that triggered by initial interest (and purchase of USG last year).

At the time I did a quick DCF and determined that USG was almost 20% undervalued. The recent release of USG's 10K provided a good opportunity to review my DCF and revise my write up.

The stock was also the subject of a presentation by Whitney Tilson at last fall's Value Investor Conference in New York. Tilson's enthusiasm surpasses mine, primarily due to the fact that my valuation model prices in a large decline in the gypsum wallboard market due to a decline in housing construction that Tilson's USG model does not.

That's right, USG's primary product is Sheetrock, the top wallboard brand in the world and the biggest use of that product (45% of revenue) goes into new home construction and yes, new home construction is going to be weak. However the fear this decline inspires in investors, coupled with USG's messy financial statements (due to a recent asbestos and bankruptcy settlement) have lead to a cheap price for the stock, so cheap that I am willing to tough out a housing decline.

Take a look at my write up and model and let me know your thoughts, USG is currently my largest stock holding and I'm interested in feedback.

USG Write Up

USG Valuation Model

Timothy Burger
timothyburger(at) gmail.com

The Best Job Ever

Warren Buffett has announced he will be hiring an understudy to learn from him and eventually take over as CIO of Berkshire:

From the recently released Berkshire Annual Letter to Shareholders:

"I have told you that Berkshire has three outstanding candidates to replace me as CEO and that the Board knows exactly who should take over if I should die tonight. Each of the three is much younger than I. The directors believe it’s important that my successor have the prospect of a long tenure. Frankly, we are not as well-prepared on the investment side of our business. There’s a history here: At one time, Charlie was my potential replacement for investing, and more recently Lou Simpson has filled that slot. Lou is a top-notch investor with an outstanding long-term record of managing GEICO’s equity portfolio. But he is only six years younger than I. If I were to die soon, he would fill in magnificently for a short period. For the long-term, though, we need a different answer.

At our October board meeting, we discussed that subject fully. And we emerged with a plan,which I will carry out with the help of Charlie and Lou. Under this plan, I intend to hire a younger man or woman with the potential to manage a very large portfolio, who we hope will succeed me as Berkshire’s chief investment officer when the need for someone to do that arises. As part of the selection process, we may in fact take on several candidates.

Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful long term investing than brains and performance that has recently been good.

Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.

Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I’ve seen a lot of very smart people who have lacked these virtues.

Finally, we have a special problem to consider: our ability to keep the person we hire. Being able to list Berkshire on a resume would materially enhance the marketability of an investment manager. We will need, therefore, to be sure we can retain our choice, even though he or she could leave and make much more money elsewhere.

Timothy Burger
timothyb(at)timothyburger.com