The next Warren Buffett or the next Berkshire Hathaway

Every investor wishes he had bought Berkshire Hathaway shares 25 years ago. If you had $10,000 invested with Warren Buffett in 1982 the shares would be worth $1,280,000 in 2006. Berkshire Hathaway shares are undervalued at the moment and will have consistent and above average growth for years to come, but the law of large numbers dictates that the company is too big. You cant get the same 25-30% annual returns from Berkshire Hathaway anymore. We missed out on Berkshire Hathaway but we could look for companies that may turn out to be “The Next Berkshire Hathaway”.

What to look for in the search for the next Berkshire or Buffet

• Company is run by a Brilliant money manager(s)
• It follows value oriented investing
• The investments are diversified across industries so a downturn wont affect the business.
• Insurance backed so the company can use float generated with positive underwriting to create wealth. Free money is always good.
• High levels of Management ownership, which orients management goals with those of the shareholders
• Focus on long term growth of Shareholder value and not on keeping the dumb anylasts on wall street happy every quarter.
  

It will be nearly impossible to find a perfect match but we can look for companies that match 2 or more criteria.

1. Sears Holdings led by Eddie Lampert (SHLD).
Eddie Lampert started ESL investments in 1988 with 28 million. ESL has averaged 28% a year for the last 18 years. Eddie Lampert is one of the best money managers in the world. Recently he took a bankrupt K-mart and turned it into a cash cow. He merged k-mart with sears to form sears holdings. The stock has been on a tear since Kmart came out of bankruptcy, it opened for trading at $16 in May 2003 and now trades at $160. Eddie searches for companies that are seriously undervalued, he also sticks to companies whose industries he understands. The board has given Lampert the freedom to invest the profits from sears holdings any way he sees fit. Just as Buffett did with Berkshire Hathaway in the 60s. If any person will take over from Buffett as the greatest money manager of the current generation it looks to be Eddie lampert, and the vehicle through which he will reach there is Sears Holdings.

• Brilliant money manager(s) – Yes
• Value oriented – Yes
• Diversified – Not yet but board has given Eddie Lampert the flexibility to do so.
• Insurance backed – No
• Management ownership – Yes
• Long term growth – Yes

2. Brookfield Asset Management (BAM).
A canadian asset management company which focuses on industries that need lots of capital such as real estate, natural resources, energy and financial service. Assets include 70 office properties, 120 power-generating plants, thousands of acres of timber and a property development operation under the Brookfield brand name. The stock has moved from $8 to $50 in 5 years thanks to the brilliant investments its management has made.

• Brilliant money manager(s) – Yes but not in same league as Buffett.
• Value oriented – Yes
• Diversified – Yes
• Insurance backed – No – Brookfield uses low cost debt which is the next best thing to insurance.
• Management ownership – Yes
• Long term growth – Yes

3. Leucadia National Corp led by Ian Cumming (LUK).
Leucadia is an investment company run by two brilliant money managers Ian Cumming and Joseph Steinberg. The company invests in anything that can make the shareholders money. Their preferred investments are generally turnaround plays. Leucadia will buy large stakes in a distressed company. They revive the company, improve performance and then sell it off at a nice profit. The company is currently diversified into telecom, manufacturing, healthcare, banking, real estate and wineries.

• Brilliant money manager(s) – Yes
• Value oriented – Yes but riskier than Berkshire as Ian cumming seems to go for higher risk companies
• Diversified – Somewhat. Cumming occasionally likes to make extremely big investment bets.
• Insurance backed – No
• Management ownership – Yes
• Long term growth – Yes

4. Markel (MKL)
Markel is an insurance holding company. The company is a mini Berkshire any way you look at it. Extremely steady and consistent growth. Like Berkshire the company has never declared a split and the shares have risen from their 1986 IPO price of $8.33 to nearly $400 in 2006. The company holds diversified investments in a large number of stocks. The top 10 current holdings are Berkshire Hathaway, Carmax, Diageo, Fairfax Financial Holdings, Anheuser-Busch, General Electric, White Moutains Insurance, Citigroup, Exel Ltd, Brookfield Asset Management. Its funny how they seem to like Berkshire and other companies that look like Berkshire.

• Brilliant money manager(s) – Yes but not in the same league as Buffett
• Value oriented – Yes
• Diversified – Yes.
• Insurance backed – Yes
• Management ownership – Yes
• Long term growth – Yes

5. White Mountains Insurance (WTM).
This company has Buffetts blessings. White Mountains is 16% owned by Berkshire Hathaway. The way the company operates it seems to be another mini Berkshire. The operating principles, view of the management and their operating principles are an exact match with Berkshire.

Operating Principles – White Mountains cares most about the following.

• Underwriting Comes First
• Maintain a Disciplined Balance Sheet
• Invest for Total Return
• Think Like Owners

Other Excerpts – “Intellectually we really don’t care much about leaving our capital lying fallow for years at a time. Better to leave it fallow and to wait for the occasional high-return opportunity. Frankly, sometimes shareholders would be better off if we just all went to play golf.”

“We also admire Benjamin Graham who said: “In the short run the market is a voting machine; in the long run it is a weighing machine.”

• Brilliant money manager(s) – Yes but not in the same league as Buffett
• Value oriented – Yes
• Diversified – Yes
• Insurance backed – Yes
• Management ownership – Yes
• Focus on long term growth – Yes

6. Interactive Corp led by Barry Diller – A Futuristic Berkshire Hathaway
Barry Diller (the CEO of IACI) says the comparison is “undeserved at present but not my hopes and dreams”. He also says that the web will help IACI fit its pieces together in a manner that Berkshire’s parts from Insurers to Manufacturing, just cant. IACI has sales that will reach 7 bilion this year and a ton of cash but the company trades at just 8.5 billion. The company is spread across a lot on industries including Retailing which includes Home Shopping network; Ticketing with Ticketmaster; Real Estate with Lending Tree, RealEstate.com and others, Online search includes Ask.com, Excite, etc..

I know IACI is a far stretch but the company is undervalued, has leading sites in their business segments a great CEO.

• Brilliant money manager(s) – Barry diller is an ok money manager but hes a brilliant CEO
• Value oriented – If theres such a thing as a value based investment on the internet
• Diversified – Yes
• Insurance backed – No
• Management ownership – Yes
• Focus on long term growth – Yes

Conflicts : I own shares of Berkshire hathaway and Interactive Corp.

Has gold lost its glitter?

Gold is a precious metal that for many centuries had been used as money, a store of value. Gold is an asset that it is rare, tangible and liquid (easily traded). Its high density and high value per unit mass make storing and transportation easy. Gold is unaffected by heat, moisture, oxygen and all corrosive compounds except aqua regia. This made gold the perfect metal for trading and eventually banking.

Gold prices have been soaring from its 1999 bottom at $252 to $730 in 2006. Prices have dropped off since, but the Gold bulls say the metal will move much higher. Most of them are proponents of Full Reserve banking with gold as the backing asset aka the gold standard. Of course they want full reserve banking, it would increase the value of the gold they own. It sounds good in theory but its not going to happen, lets look at some numbers. It’s estimated that all the gold ever mined totalled 145,000 tonnes, this equates to a value of $3 trillion in April 2006. The US Money supply known as M2 consists of cash, checking, savings, money market and CDs is 6.5 Trillion. So to back up its currency with gold the US would need to buy twice the amount of gold mined in history.

Gold lost any role it had as a form of currency with the end of the Brentton Woods system in 1971. Since then most banks have been selling their gold reserves. Now the only factors that determine gold prices are supply and demand. Excluding its past as a form of currency, gold has limited use. Its major uses are Jewelery, Dentistry and Electronics. Compare this with other metals and you realise that the metal is pretty useless. Unlike base metals gold never gets used up, its advantage of being non corrosive and unaffected by the elements means that virtually all the gold ever mined still exists and can come onto the market at the right price.

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Warren Buffett – 1998

The few positives for gold are. Its tangible so if the investment is made in the actual commodity the value will never go to zero. In times of war when hyperinflation takes over, currencies become worthless but physical gold will hold its value (Its for gold bugs that fear war, the second depression or armageddon is just around the corner). I personally dont believe in the future of gold unless someone finds commercial use for it. Whatever glitter gold may have had in the past it’s long gone.

For people looking to invest in gold I ve included the bull and bear arguments and the various options to owning gold.

Gold bull argument

• Demand from India, China and the middle east has increased because of increase in disposable incomes.
• Russia, China and a few other central banks may increase gold reserves to protect themselves from overexposure to a falling dollar.
• The huge US trade defecit means the dollar will lose value over the long term and Gold will move higher.
• There is increased demand for gold from investors that can buy small quantities thru ETF’s like Streettrackers Gold GLD
• International conflict, terrorism or uncertanity increases demand for gold because people buy it as a form of insurance.
• The new gold supply is 2500 tonnes while demand is 3500 tonnes. The difference is being made up by Bank sales, scrap sales and hedging.

Gold bear argument

• India, China and middle east economies are based on trade with the US. When the dollar decreases the disposable income in these countries will decrease which will in turn reduce gold demand.
• Currently the Chinese and Indians are in a transition period, their cultural belief of gold as a form of investments and a status symbol coupled with increased incomes has increased gold demand. Both these countries are getting increasingly americanised and in the not too distant future stocks will be their preffered form of investment and gadgets, sports cars etc will take over from gold as status symbols.
• There are better ways to invest against the falling dollar. Gold has doubled in value compared to the US Dollar but most of this gain in due to the dollar falling against currencies like the Euro. If your investments were in Euros the gains would work out to just 35%. Its better to invest in international stocks as a hedge against the falling dollar.
• Its best to buy gold when its low. For now the gold bull market is over. Gold along with energy usually peaks at the top of a stock market cycle. We’ve moved from that phase to the start of a bear when consumer non-cyclicals and healthcare are the new darlings.
• Banks still hold around 25,000 tons which could come onto the market at the right price. Currently all government banks combined are restricted to sell 500 tonnes anually.
• Gold was in a 20 year bear market and unprofitable mines were closed, very little exploration was taking place. With current prices of gold there will be a lot more supply coming online.

Investing options – There are different ways to invest in gold and the investment option depends on the reason for investing in gold. Some people buy it as a form of insurance, while others want to invest in gold as a hedge or to diversify their portfolio.

Insurance: If the reason for investing in gold is to hold it as a form of insurance against Inflation or Hyperinflation the best option is to buy gold Coins or Bars. Coins are easier to trade and they are easier to hide. Another plus for coins is they are gauranteed by governments v/s bars that are gauranteed by mining companies. The coin with the smallest premium over the gold price is usually the South African Krugerrand. The following 1 ounce gold coins are the most common.

• Australian Nugget
• Austrian Philharmonic
• British Britannia
• Canadian Maple Leaf
• Chinese Panda
• South African Krugerrand
• USA Gold Eagle

If you dont want to buy physical gold you could invest in Streettrackers Gold GLD which allows you to own gold without the hassle.

Low Risk Investment – Invest in a Gold or Metals and Mining fund. The safest way to invest in gold stocks.

• Vanguard Precious Metals and Mining (VGPMX)
• Evergreen Precious Metals (EKWAX)
• USAA Precious Metals and Minerals (USAGX)
• First Eagle Gold (SGGDX)
• Oppenheimer Gold and Special Minerals (OPGSX)

Medium risk Investment : Major or low cost Gold Producers, Diversified Mining companies

• Anglo American (AAUK)
• Barrick (ABX)
• Newmont Mining (NEM)
• Goldcorp (GG) – Lowest cost producer but extremely poor management in my opinion.

High risk Investment: Minor Gold producers which are usually takeover targets for major producers to increase their gold reserves.

• Yamana Gold (AUY)
• Crystallex (KRY)
• Tanzanian Royal Exploration (TRE)

Investing in the video games industry

The video games industry is one of the fastest growing industries in the world. Its the creation of a new form of interactive entertainment. The industry is growing rapidly and will soon be bigger than the movie industry.

The “King of games”.
For years Nintendo was the king of video games, every competitor that challenged it was summarily demolished. The NES and SNES (Famicom in Japan) made Nintendo a synonym for video games. Their high quality in-house games and memorable characters like Mario, Zelda, StarFox, DonkeyKong started franchises that still sell games by the millions. Nintendo also introduced quality control of third party developers to made sure that customers had great games to play. As the video games industry took off competitors introduced competing consoles like Sega MegaDrive/Genesis, 3DO, Atari Jaguar, Sega Saturn, but they all failed because they didn’t have the games to back up the hardware.

The new kid on the block.
It was not until the PlayStation launch in 1994 by Sony that Nintendo faced its first true competition. The PlayStation was first to market. Sony introduced the CD format which had 10 times the capacity of a Nintendo cartridge which gave game developers creative freedom they never had on 32MB cartridges. The PlayStation was much easier to program than the N64 which helped Sony attract a lot of third party developers to PlayStation. When Nintendo released it Nintendo 64(N64), Sony already had a stranglehold on the market. What Sony saw was the creation of a new form of entertainment. The PSX has gone on to sell 100 Million units over 11 years and the PS2 surpassed that number in 7 years.

Two is company, three is a crowd.
Microsoft got its taste of the video game industry when it developed the operating system and development tools for the Sega Dreamcast. The growing video games market seemed to threaten the PC market which generated most of Microsoft’s revenue. The XBox was also a chance for for Microsoft to diversify it’s revenue stream, it joined the console wars in 2001.

What next?
The Next-gen Console wars are upon us. The competitors are Microsoft, Sony, Nintendo. The victor will receive control over a hundered million households.

Console Manufacturers
The money is made not in the hardware sales, usually consoles are sold at a loss. The profits flow in from licensing deals with software developers who want to publish games for the console. The more games that get developed and sold the higher the profit for the console manufacturer. The number of games developed and sold is directly proportional to the number of units sold.

Sony PS3 (SNE): The PS3 is a difficult release for Sony. Game developers like consoles to be positioned exclusively for gaming and not as media units. Selling a console as a media unit means game developers have no idea how many units were purchased for the purpose of gaming. Another risk factor for Sony is the price point, usually consoles sell for around $299-$399 at launch. At launch the PS3 will sell for $599-$699, agreed that it has a Blu-Ray player but the price is twice the XBox360. Sony lost the VHS v/s Betamax wars and is trying to win the HD-DVD v/s Blu-Ray wars. I’m afraid Sony may win the Hi-Def wars but lose the console wars.

Microsoft XBOX 360 (MSFT): First out of the block its projected to have 10 million units shipped before PS3 or Nintendo Wii make it to market. Improved production lines mean it will be able to cut prices when the new consoles launch, further improving unit sales.

Nintendo Wii (NTDOY): The new unique controller with motion detectors will provide a unique gaming experience. The Nintendo image of high quality kids friendly games will sell units to pre-teen audiences. Nintendo’s gaming franchises will also help sell a lot of consoles, especially in Japan. It wont win the console wars but it will be extremely profitable. Unlike Microsoft and Sony, Nintendo doesn’t depend on third party developers. It has the best game development unit in the world. The company can release a Mario, Zelda or Pokemon game and sell 5-7 million consoles.

Microsoft and Sony will sell more consoles but the video game revenues are a small part for both companies. As a pure play on video games Nintendo wins. Even without the console market Nintendo would do fine because its Game-Boy dominates the handheld market. The PSP isn’t even worth mentioning

Game Developers
As consoles improve independent game developers are closing down. Better hardware mean the customer expects better looking games. They want games that look as good as movies. The production costs of games are skyrocketing, with some games costing as much to develop as blockbuster movies. This has led to significant consolidation in the industry. The only companies that will survive are the big publishers.

Electronic Arts (ERTS): EA has excellent sports franchises which lets them publish sports games with minor tweaks every year that sell millions. It also controls franchises like The Sims, Battlefield, Medal of Honor etcetra that are million unit sellers. The best part about EA’s business is that it develops all games for all consoles, so it doesn’t matter which hardware manufacturer wins EA get its software sales.

Konami (KNM): The company that created the Dance Dance Revolution craze (I’m sure you’ve seen kids dancing on the floor-mats) has a lot of franchises like Metal Gear, Bomberman and Silent Hill, each of which will be made into multiple games for various consoles. The company posses a brand recognition in Japan that ensures its games will be blockbusters.

I like the consistency in earnings of Konami over EA. The majority of Konami’s revenue comes from console games but Konami also has some Arcade, Toy, Mobile and Casino gaming exposure that helps it weather the downturns in the industry at the end of each console generation.

Others: I do not like any of the other game manufacturers like Activision(ATVI), THQ(THQI), Atari (ATAR) and Taketwo(TTWO). They dont have the size, financial strength or game library/franchises that EA and Konami have. The one company i would love to own is Blizzard (Vivendi), too bad its not an individual company

Services
The only ones i know of are Shanda(SNDA), Netease(NTES) and The9 (NCTY). The companies provide services for On-line gaming and on-line communities. They’re just too risky.

Retail
Wal-mart and Best-Buy sell a lot of consoles and video games but there is only one company that is exclusively a video game retailer.

GameStop(GME): is the world’s largest video game retailer. The company operates 4,500+ retail stores throughout the United States, Austria, Australia, Canada, Denmark, Finland, Germany, Italy, Ireland, New Zealand, Norway, Puerto Rico, Spain, Sweden, Switzerland and the United Kingdom. To GameStop it doesn’t matter who wins the console wars and it doesn’t matter which game developer get the next blockbuster franchise. If the industry grows GameStop will mint money.

Best way to invest in video games : GameStop(GME)
Alternative : Nintendo (NTDOY)