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New opportunities, Timeless Principles.

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Beyond Buffett

Buffett does not invest in the technology

companies or international companies or

small (public) companies because they are

outside his circle of competence; his tenets

can be applied to investing in any company,

any industry, any market.

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Application in other areas

Technology companies Small companies International stocks

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What are the problems?• Less certainty

Solution• Higher margin of safety

• Buy less (as a percentage of your wealth)

Hagstrom sees?

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How do the big 12 fit? Small-Tech-Int’l

Simple/understandable? Consistent operating history? Favorable long-term prospects? Rational management? Candid management? Resist herding?

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How do the big 12 fit? (The sequel)

Focus on ROE, not EPS? Calculate “owner earnings” High profit margins? A dollar retained → A dollar market value? Determine value of business Can purchase at discount?

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Bill Miller – Technology stocks

CEO Legg Mason Funds and Manager of Value Trust

Profiled as one of the five heroes of value investing.

Adapted Buffettology to investing in the New Economy stocks (Recall Level 3)

http://www.leggmason.com/funds/ourfunds/managers/bill_miller.asp

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The Sales Pitch At the end of 2003, Value Trust became the only fund

to have outperformed the S&P 500 each of the past 13 calendar years. Keep in mind that past performance is no guarantee of future results.

“I am confident the bear market is over and that the probabilities favor much better results than we experienced in the past five years…Whether…provisional beliefs turn out to be true, please be assured that no one will work harder or care more about your money than the Value Trust team.”– Bill Miller, Portfolio ManagerApril 19, 2004

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Value stocks

Low Market-to-book ratio.• Market Price / Book Value

Low Price-to-Earnings ratio.• Market Price / EPS

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Miller’s argument

This line of thinking is flawed because value does not depend on market price, it depends on the future cash flows.

The trick is value the future cash flows rationally and buy them at a big discount.

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What is different about tech co.’s• Uncertainty.

• High M/B and PE ratios.

Do sensitivity analysis. Keep higher margin of safety. Invest a lower percentage of your wealth.

So did we get them all?

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What is similar about tech?

• high profit margins,

• high returns on capital,

• the ability to reinvest the profits back into a fast-growing company, and

• management that acts in the interests of shareholders.

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The Franchise Factors

“Yes, people are still buying Coca-Cola and Gillette

razor blades, and using their American Express Card,

but they are also using America Online, and Microsoft

software, and buying Dell computers – and that’s

ubiquitous.”

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The Franchise Factors for Tech Network effect

• “Everybody I know is on AOL…”

Positive feedback

Lock-in• VHS technology and Computer Keyboard.

Increasing returns• Low capital expenditure is needed to increase sales.

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Case Study: AOL and the Buffett Tenets

Simple and understandable? Yes.

Consistent Operating history? No, new.

Favorable long-term prospects? Yes.

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Rational management? Yes.

Institutional Imperative? Yes.

Candid management? Yes and No.

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ROE?

High profit margins? Yes.

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What is the value? In 1996, Bill Miller calculated it to be $7.5 billion as compared to the market price of $4 billion.

Discount? His average cost is $1.75 as compared to a market price (after a steep fall) is around $17.

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AOL and the Technology Franchise Factors.

Network effect -

Positive feedback

Lock-in: flat rate.

Increasing returns.

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Smaller and Mid-Cap Stocks

Why Buffett does not invest?• Too small for his big pool of funds.

• Market impact

• Lack of liquidity

• Will invest if can buy “whole” business

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Wally WeitzWallace R. Weitz & Company (Estd. 1983)

Mid-cap funds

• Weitz Value Fund

• Weitz Partners Fund

Small-cap fund

• Weitz Hickory Fund

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Similarities with Buffett

Both operate from Omaha, Nebraska.

Weitz tries to determine what a rational buyer would pay if that buyer had the opportunity to purchase 100 percent….

Does the company have some special market niche, or a franchise value?

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Like Buffett, he sticks with businesses he can understand.

Seeks businesses that generate excess cash and have honest managers.

Low turnover – 20 to 30 percent per year.

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Small-Cap Companies - Problems

Until they have gained substantial market share,

they are potentially greater economic risks.

Low liquidity

• Require low turnover.

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Advantages

They tend to be less complex, less bureaucratic.

Their managers are often more accessible.

Less covered

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International Stocks - Challenges

They may have different accounting

standards.

There is a risk that the currency will decline

relative to the dollar.

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It is more difficult to interview management.

Political, social and economic turmoil can

ruin companies and swallow the expected

gains.

Why hasn’t WB done much Int’l

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Mason Hawkins, Southeastern Asset Mgt.Longleaf Partners funds.

Concentrate on cash and not the accounting

figures.

Only buy if it is selling for less than 60 cents for a

dollar.

Shareholder oriented “good” managers

Non-diversified investments.

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Hedge the currency risk, add the cost of

hedging at the valuation stage.

Travel to collect the information.

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Essential To Look For – Anywhere, Any Time

“Good businesses that generate great economies

run by smart managers available at cheap prices.”