Issue #53, Volume #2
Criticize Buffett, And I’m Blackballed Forever
This is Porter’s Daily Journal, a free e-letter from Porter & Co. that provides unfiltered insights on markets, the economy, and life to help readers become better investors. It includes weekday editions and two weekend editions… and is free to all subscribers.
| There are things you are not allowed to say, ever… My dad is one of those magical people… Shares of Coke have grown at 14% per year since 1979… Hershey is better than See’s Candy, Home Depot is better than Mrs. B., McDonald’s is way better than Dairy Queen… Own only great businesses – it’s that simple… UK-U.S. auto trade deal a bust… |
What you’re about to read could end my entire career.
Why write this?
My longtime readers already know: I can’t help myself.
I write what I believe I would most want to know if our roles were reversed. And I write that every time, regardless of the consequences. Sometimes I wish I was normal. But I just can’t help it.
For the first time in my life, I am sincerely and honestly scared. I took on the entire federal government in 2002 – exposing an ongoing securities fraud at the Department Of Energy – and I wasn’t worried. That was dumb and naïve. But this will probably cause me even bigger problems than that.
There are things you are not allowed to say… Ever.
Readers who are new, you will think I’ve lost my mind. You will, almost surely, be offended and accuse me of deceit – or even fraud. Longtime readers will shake their heads and simply shrug. “That’s Porter…”
You see, I am about to reveal a very painful truth. It’s something that most of you will simply refuse to believe. No matter how sophisticated my analysis.
That’s a shame, because the lesson that lies behind this analysis is one of the most valuable things you could ever learn about investing.
And I promise, nobody will ever tell you this simple truth.
Understanding it will make wealth relatively easy to achieve. And that’s why no one will tell you these facts. And that’s why I’m essentially shooting myself in the face, in the hope that you’ll recognize this amazing truth about capitalism.
Actually, it’s even bigger than that…
This is part of a universal truth. Something that’s true about humanity, about nature, about physics. There is an underlying architecture. And this reveals it.
Ironically, most of you simply won’t believe this. It doesn’t matter that everything I write below is accurate and true. And is easily confirmed by any competent and honest analyst.
The really sad part? Most of you will stop reading out of disgust. The reality of humanity isn’t pretty. So before you call to cancel your subscription, before you call me a liar, let me tell you something about how I first came to recognize this unpleasant reality.
Let me tell you about my dad.
My dad is, without a doubt, the kindest person I have ever known. (Bill Bonner is a very close second.) Dad is a real-life Santa Claus. I was a very difficult and strong-willed teenager (shocker!). But Dad never raised his voice – not once. Rather than fight with me, he simply told me: “Porter, I believe in you. You are a good person, and you will do the right thing.”
Gulp.
I’ve never met anyone who didn’t adore my father. He’s one of those magical people who draws everyone together, again, like Bill Bonner.
I hope Dad will come to the Porter & Co. conference this fall. If so, you should meet him. He is 85 this year. He was raised in a log cabin without modern plumbing. In rural Appalachia. He’s obviously of Scottish descent, with jet black hair, wild eyebrows, enormous calves, an incredible wit, and he’s blindingly intelligent.
He also adopted me. I carry his name with the greatest reverence. In fact, when I decided to sponsor golfer Kevin Kisner on the PGA Tour, my fondest part of the deal was putting Dad’s name – Stansberry – on Kevin’s shirt. Kevin earned a second-place finish in the British Open in 2018 with my dad’s name on his breast. A very proud moment for our family.
My dad lost his job at SunTrust Bank in the aftermath of the 1973-’74 financial crisis, due largely to President Richard Nixon’s gross mismanagement of the U.S. economy.
Dad had been a well-known writer for BusinessWeek. He moved along to public relations for the most important bank in the Southeast. He found himself, quite suddenly, in financial peril. No income. A wife. Two adopted children (my brother and I).
I’ll spare you many details, but he had one goal: get a job at Coca-Cola. Why? It was the premiere business in the South. He landed that job in 1979. He stayed with Coke until his first retirement in 1996. And he made an incredibly important decision: he invested all of his savings into Coke (KO) stock. That’s an investment that’s grown at around 14% a year since 1979.
I’ll never forget the crash of 1987. My mother was terrified that their savings would be lost. Dad, with his normal good cheer, simply replied: “I own as much of Coke today as I did yesterday. And by the end of this year, I’ll probably own a bit more than I would have otherwise. Today is a great day for us.”
As you might know, that’s when Warren Buffett started buying shares of Coke.
This is a lesson that I’d like to teach every investor. Buy a great business. Buy more when you can. Ignore everything else.
You don’t need to be a powerful financier. You don’t need to invest in private equity funds. All you have to do is buy the best business in a good industry and never sell.
Is it really that easy? Yes!
Who is the world’s greatest investor? Most people believe Warren Buffett is the world’s greatest investor. Nobody can compete with the “Oracle of Omaha.”
Wrong.
Buffett’s Take-Private Businesses Have Lost Money
The truth is, Buffett has made a lot of lousy investments in the last 25 years – with the notable exception of his enormous investment into Apple (AAPL). And what was Apple? It was the obvious market leader in the biggest trend in the economy.
Most people believe that Buffett succeeded because he’s brilliant and because he had access to all kinds of special deals. Most people believe they must take risks and take on leverage and do all other kinds of financial wizardry because they’re not as smart or as well-connected as Warren Buffett.
But that’s all nonsense. All you must do is buy the best businesses, in the best industries. That’s all. It’s obvious. And it’s easy.
Warren Buffett’s Berkshire Hathaway (BRK) has continued to outperform the market because it profits enormously from the free use of $170 billion in capital – its insurance “float.” At the last annual meeting, Berkshire’s head of insurance, Ajit Jain, revealed Berkshire has earned 2.2% per year on underwriting profit on its float. That’s an enormous accomplishment. But the impact of getting to invest $170 billion of other people’s money, completely for free, is lost on the public.
Here’s the truth: Berkshire doesn’t beat the market because of Buffett’s investing. It beats the market only because of its property & casualty (P&C) insurance companies and their legendary underwriting.
And here’s what no one is allowed to talk about: on a weighted basis, Buffett’s largest take-private investments have lost money.
At the end of the 1990s, Buffett made a profound shift in his investment strategy.
Rather than buying fractional ownership stakes (stocks) in the world’s best businesses, he began buying whole companies. This, of course, started – in bits and drabs – much earlier. He took Berkshire itself private in the early 1960s. And then National Indemnity, his first insurance company, in 1967. And then See’s Candy in 1972.
Making whole-company acquisitions gave him a substantial edge: he gained access to the target company’s books and records. He was able to know everything about a potential acquisition. This also gave Berkshire the ability to manage its tax liabilities far more efficiently. Rather than having to pay taxes on dividends before reinvesting the capital, buying whole companies allowed Buffett to reinvest their earnings directly, pre-tax.
Today, many individual investors believe that, to be successful, they must have an expert’s knowledge of a business – the equivalent to Buffett’s total access to the company books. And many investors have given capital to private equity firms upon the express promise that such knowledge and greater tax efficiency will earn them greater returns.
Simple question: what if none of this actually works? What if private-company investing isn’t nearly as profitable as public-company investing?
Here’s a thought experiment. What if, like my dad, you simply bought the very best business that was the clear leader in a growing market? What if you simply did the most obvious thing – you bought the largest, most-dominant businesses and held them, virtually forever? Would you beat Buffett? Sounds impossible, right?
Wrong.
Buffett Should Have Stuck With Stocks
Below you’ll see a simple chart of some of Buffett’s largest take-private transactions. No, I don’t include Gen Re because, at the time, General Re was the obvious choice in the public markets – the largest insurance company in the U.S.
What I’m talking about are the take-private investments Buffett made when there was a clear, publicly traded market leader that he could have easily bought instead. In fact, in most cases, Buffett owned or would own the public company analog that informs my comparisons.
Before you cry, “Well, of course – hindsight is 20/20,” hear me out.
Look at every comparison and ask yourself a simple question: Would any rational investor at the time not concede that the public company analog was clearly a larger and better business?
In short, with each of these investments, Buffett had a clear choice to make between a smaller (and lower quality) business that he could own 100% of – or a larger (and higher quality) public company he could own fractionally. In each of these cases, the public-company choice is blindly obvious.
Let’s start with See’s Candy. Buffett often explains how great it’s been to turn his $25 million investment into billions with a tiny privately-owned candy company. And, yes, that was a great investment! It has compounded at almost 9% a year for 50 years! But what if Buffett had done something vastly easier, that any investor could have done: buy America’s best publicly traded candy company, which in 1972 was clearly The Hershey Company (HSY) – just as it is today.
And how has Hershey performed? Well, it’s down a lot lately, but even so it has compounded at almost 13% a year! If Buffett had simply bought the most obvious, highest-quality public company in the exact same industry, over the last 50 years, he would have earned Berkshire $8 billion more in total returns than he did owning 100% of See’s Candy.
See’s has become part of Berkshire’s pantheon. And so has Mrs B.’s Nebraska Furniture Mart. Buffett has waxed eloquent about this business for 40 years. And it’s easy to see why. Once again, he’s compounded his investment at almost 10% a year – for 40 years!
But what if instead of buying 100% of a tiny, one-location, hardware and home-furnishings store in Omaha, Nebraska, he had invested the same $60 million in what was, at the time, the largest (and fastest growing) hardware and home-goods business in the country, The Home Depot (HD)? Is this rear-looking? Sure, but at any point over the last 40 years, Buffett could have made this trade. The public-company analog to the private Mrs. B. was always obvious and always available. Nothing would have been easier. And Home Depot has compounded capital at 22% a year since 1983. The difference to Berkshire? $220 billion.
Makes you feel a bit differently about Mrs. B., doesn’t it?
Just think about it for a minute. Why on Earth was Buffett putting Berkshire’s capital into a single location home-goods store when there was a national business that was superior in every way, that he could have easily bought without ever having to be involved in management? And you can’t tell me that Buffett was not aware of this massively growing delta – the outperformance of Home Depot over Nebraska Furniture Mart. There’s no doubt Buffett was regularly reading the Home Depot annual report. So, why not own the clear market leader?
And what about Dairy Queen?
There’s zero question that Dairy Queen was, and always has been, a lesser version of McDonald’s. Same basic foods. Same business model (franchise). Same basic customers, except of course McDonald’s is one of the greatest businesses in human history and Dairy Queen is… well… not even close.
And here’s a fun fact for everyone who thinks this analysis is bogus because it’s rear-looking: Buffett sold his stake in McDonald’s (MCD) in 1999, a year after he bought Dairy Queen! He chose to own 100% of a lousy business instead of owning a fraction of a great business.
The difference for Berkshire holders? About $8 billion so far. Again, this huge delta has been obvious for every year that Buffett has owned Dairy Queen – and he’s even written what a huge mistake it was to sell McDonald’s. So why has Buffett consistently bought 100% interests in lousy businesses instead of simply owning the world’s best businesses, which are for sale every day in the stock market?
And here’s another deal that just makes no sense.
Buffett has written at length about why owning airlines is a terrible idea. So why then in 1998 did he buy a private airline – NetJets? And it looks like just as he was buying NetJets in 1998, he was selling General Dynamics (GD). Why does that matter? It matters because, in 1998, Gulfstream – the maker of the world’s best business jet – was for sale. Rather than buying NetJets, Buffett could have bought Gulfstream! And guess who did? General Dynamics – the company Buffett sold just as he was buying NetJets! What’s a better idea, trying to run a private airline or building the world’s best business jets?
Are you going to cry rear-looking? Buffett owned General Dynamics! All he had to do was nothing. And try to explain this: when NetJets had done nothing but lose money for more than a decade, what did Buffett do? He poured another $10+ billion into buying still more planes for NetJets. He should have bought General Dynamics instead, the maker of Gulfstream planes. And if he had? The difference to Berkshire shareholders? $73 billion.
There’s no use going through the entire list. You can see for yourself.
Instead of buying all of Benjamin Moore, Buffett could have bought the industry’s clear leader Sherwin-Williams (SHW). Difference to Berkshire? $21 billion.
Rather than buying a mobile-home maker, Clayton Homes, he could have bought NVR (NVR) – the country’s most profitable home builder. It had appeared as a recommendation in the Value Investors Club and was, even back then, well-known to good investors as the very best homebuilder in the country. By the way, Berkshire owns it today! Difference to Berkshire? $20 billion.
Rather than buying Russell Athletic (maker of Brooks running shoes), Buffett could have bought Nike (NKE). This was a no-brainer in 2006. Difference to Berkshire? $3.3 billion.
And, finally, what I think is the most interesting mistake – instead of buying Pilot Flying J truck stops, he could have bought shares in Couche-Tard (ATD), with brands like Circle K convenience stores. Difference to Berkshire? $11 billion.
Buffett has consistently done best when he bought the absolute market leader, in the public markets: American Express (AXP), Coca-Cola (KO), Apple (AAPL), Moody’s (MCO) are prime examples. When he hasn’t bought the clear market leader he’s almost always made a mistake.
Buffett’s Two Biggest Mistakes
I’ve written about Buffett’s ill-fated and disastrous decision to invest massively into tightly regulated utilities and energy-related infrastructure. So far he’s lost Berkshire about $50 billion on these investments, if you trust the mark-to-market price for Berkshire Hathaway Energy (“BHE”) that Buffett used last fall to buy out the estate of his longtime friend Walter Scott.
There isn’t an obvious public analog to these regulated utilities, but Buffett should have never made these investments – period. If he wanted to own energy, the best energy business in the history of capitalism is ExxonMobil (XOM). So I’ve run an analysis here of buying ExxonMobil instead of the half dozen different energy businesses that Buffett has bought to build BHE. Difference to Berkshire? More than $150 billion.
And that’s not Buffett’s biggest mistake.
In 2006, Chris Hohn, the legendary British investor behind the The Children’s Investment Fund, began taking an activist position in railroads, including CSX in America. He pitched his thesis that railroads were deeply undervalued to hedge funds and other very knowledgeable professional investors. Everyone knew the rails were in play. And Buffett invested in the idea, buying stakes in America’s best railroads: CSX (CSX), Norfolk Southern (NSC), and Union Pacific (UNP). He sold these stakes to buy 100% of BNSF Railway, which has long been the worst performer in the industry. So what if Buffett hadn’t picked one railroad to own 100% of, but instead had simply invested heavily into the basket of railroads that he already owned? It would have been a difference to Berkshire of $188 billion.
Looking at all of these investments, you’ll discover something shocking: Warren Buffett has lost money, cumulatively, on a capital-weighted basis, mostly because of the huge losses at BHE.
It Doesn’t Have To Be Hard – Just Invest Like My Dad
These situations make clear Buffett’s biggest mistake: rather than investing in market leaders, he chose, repeatedly, to buy so-called value businesses, where he could own 100% of the shares. That strategy has been a colossal failure.
But here’s the good news. You don’t have to make these mistakes. Just learn to invest like my dad – in the biggest, most obvious market leaders. If Buffett had just made those easy choices, Berkshire would be more than twice its size today (on an enterprise value basis).
That’s a difference of over $700 billion.
If you haven’t condemned me to hell for daring to criticize Saint Warren, maybe this next part will do the trick. Here’s another obvious truth that you’re not allowed to say.
Most people, and most businesses, aren’t worth very much. There is a natural hierarchy in the world, a hidden order. If you think about your own life and you think about the very few truly exceptional people you’ve ever known personally, this will crystalize for you.
Likewise, very few businesses are exceptional. We know that less than 20% of the companies in the market will collect virtually 100% of the profits over time.
This distribution is known as Pareto’s Law.
In finance, this natural distribution creates a “power law” dynamic in the equity markets where a very small number of companies capture most of the profits. Over time, this advantage is massive.
Buffett would have been far better off focusing on the clear power-law winners, rather than trying to buy marginal businesses at a cheap price.
The reality is, Buffett, like many investors, often dismissed the obvious advantages of simply buying the world’s best businesses and holding on to them. And that’s the good news: Investing doesn’t have to be hard.
We just make it hard because we deny what’s right there in front of us.
Here’s a hint: just buy the very best business in an industry that you expect will grow. Check back in a decade. If it’s not working by then, sell it. Until then, do nothing.
One more thing…
The main reason, I suspect, that Buffett wanted to have control of these marginal businesses is that he thought he could direct their capital flows into better opportunities, like he did after buying Berkshire Hathaway. And, undoubtedly, he did. Berkshire, as a whole, has done very well – due almost exclusively to his public-company investing and his insurance-company holdings.
So how can you build your own Berkshire? Here’s a hint.
Only own great businesses (return on equity of at least 15% a year) that actively buy back huge amounts of their own valuable shares. Like Buffett does when he owns a whole company, you’ll benefit from these compounding returns. High quality businesses that buy back their own shares in large quantities are, pretty much, wealth-creation machines.
Just set it and forget it.
You’re welcome.
Three Things To Know Before We Go…
1. U.S. manufacturing activity collapses. In April, the Institute for Supply Management index for production levels among U.S. manufacturing businesses plunged 9%, to a monthly reading of 44. This is below the lowest levels reached during the COVID-19 lockdowns, and a level only seen during the prior recessions caused by the dot-com bubble and the Great Financial Crisis. If history is any guide, the U.S. economy could be sliding toward recession.
2. Subprime auto-loan bust sets new record. The percentage of subprime auto loans more than 60 days delinquent rose to 6.6% in January, the highest level on record going back to the 1990s. Subprime consumers are getting squeezed between higher car prices, averaging about $50,000, and rising insurance costs, up 19% year-on-year. The Trump tariffs will likely add even more to the price of a car, accelerating the subprime auto bust.
3. Trump’s trade deal with the UK backfires for U.S. automakers. The American Automotive Policy Council, which endorsed Donald Trump’s candidacy, attacked yesterday’s U.S. trade deal with the UK. The group noted that the terms will make it cheaper to import a UK vehicle with “very little U.S. content” versus one imported from Mexico or Canada that contains up to 50% American-made components. Another unintended consequence of the Trump administration’s attempt at reordering the global trading system.
Tell me what you think: [email protected]
Good investing,
Porter Stansberry
Stevenson, Maryland
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