Capital Allocation: The Financials of a New England Textile Mill 1955-1985

[wabuffo]

https://www.amazon.com/Capital-Allocation-Financials-England-Textile/dp/B088B96JRK/ref=tmm_pap_swatch_0?_encoding=UTF8&qid=&sr=

 

Books about Warren Buffett are usually a dime a dozen.  Despite the long title, this is a Buffett book that I heartily recommend.  A warning, though, this book is for the wonkish, financial analysis types like me who enjoy poring over balance sheets and sources/uses of funds tables rather than hearing heartwarming stories about Buffett and Munger via their pithy "words of wisdom".  Instead, this is what I call a "meat and potatoes" kind of book about the blocking and tackling that traces the path from the textile business into the modern day BRK colossus that starts to appear in the late 70s in the form we recognize today.

 

In Buffett's life's work, I've always felt there is a "donut hole" between the end of the Buffett Partnership (BPL) in 1969 and the "birth" of the modern Berkshire Hathaway in and around 1977.  This is a time when Buffett was mostly silent in terms of writing to his shareholders.  This was largely due to the fact that he did not have a unitary vehicle during this period (like BPL or BRK-only) through which he could speak to his shareholders in a comprehensive but focused way.  His investment structure during much of this time was a tangle of Berkshire Hathaway, Diversified Retailing, and Blue Chip Stamps as he exited BPL but before he consolidated his corporate structure into a single entity (BRK).  In fact, it is this tangled series of structures and cross-ownership that got him (and Munger) in trouble with SEC (back when people feared the SEC, LOL) for possible fraud in their actions that might have caused the failure of a Wesco-Financial Corp of Santa Barbara merger in 1975.  As an outcome after that legal near-miss, Buffett went about cleaning up the spaghetti-chart corporate structure and the "modern" Berkshire Hathaway was born.  With that done, starting in 1977, the BRK "Chairman's Letter" started giving Buffett back his voice in a format that hasn't changed much since.  In addition, by the late 80s, the AGMs started to draw investors to hear him and publications like OID began printing transcripts.  But during most of the 1970s none of this existed.

 

I like this book because the author uses financial sources (annual reports, 10-Ks, insurance industry regulatory filings) to trace a path through the capital re-allocation that occurred from the original BRK textile business control position to the National Indemnity purchase through to his other investments into Illinois National Bank, Diversified Retailing and Blue Chip Stamps.  It fills out for me, which structure purchased which investments and really breaks down how funding capital was created from, say, the textile business, to buy the insurance business.  It also goes into great financial details about investments in this period that not much was written about like Pinkertons, Detroit International Bridge, etc because they fell into the "donut hole" of the Warren Buffett experience.

 

It also becomes much clearer why Buffett shut down the BPL fund, at least for me.  While his reasons of an overvalued market are a factor, I think this book shows the other factors.  For one, in 1967, he had found a large source of permanent capital via the float of National Indemnity.  Also, equally important, he was starting to buy common stock investments outside of his Buffett Partnership.  I hadn't realized that by the late 60s, BPL no longer owned 100% of his marketable securities.  He owned DIS in 1966 via the BRK textile biz b/s (and not BPL).  In 1968, he had added to his AXP position on the BRK textile biz b/s (among many other stocks).  His investment focus was probably fragmenting plus he no longer needed the "hot" capital of his investors anymore - so perhaps that created the impetus to wind down BPL.

 

One also realizes, that far from the success it is today, the insurance business was a slog for Buffett during this period as he tried to expand into it.  There are many failures (Home and Auto, Cypress Insurance) as well as struggles growing the reinsurance business from whole cloth organically during its first decade or so.

 

Anyway, I'm only half-way through the book.  Its definitely got a lot of numbers (and no cute Buffett cornball sayings) - and for those who already understand some terms like insurance float, there will be some pages that are less interesting.  But overall, its a big thumbs up from me and it will definitely occupy a space on my bookshelf next to the very best books about Buffett.

 

wabuffo

[John Hjorth]

Thank you for an awesome write-up, wabuffo,

 

I just ordered the book. I'm really looking forward to the study of it. [From your write-up, I suppose it's more like a study than a read.]

[writser]

Sounds interesting. Ordered the book.

[wabuffo]

cool - let me know what you guys think.

 

wabuffo

[dcollon]

Thanks for the recommendation wabuffo.  I'm looking forward to reading it.

[Munger_Disciple]

Thanks for the review wabuffo. Ordered it.

[Cigarbutt]

Good recommendation wabuffo.

I started the book and may comment on it if something comes up along the way.

---o---o---

For section III (The textile mill 1955-1962) and section IV (The investment 1962-5), i didn't verify with the original BH annual reports and rely on the numbers provided by the author (although some numbers (equity accounts, debits and credits over the years) do not exactly fit with some other references i had; i assume the author's numbers are exact or not materially different from reality). Here's a link that complements the first sections of the book:

https://www.globalfinancialdata.com/berkshire-before-buffett/

 

The investment (and the timing of this investment) made a lot of sense in 1962. The business had entered a poor trend but it was reasonable to assume that the initial investment in 1962 (share price 7.51) was made in a trough, in a company involved in a poor but cyclical industry and with a well established trend in adequate capital allocation of excess capital. It also had a significant and unrecognized tax asset from prior years. The price paid initially was at a very significant discount to liquidation. Derived from the author's numbers, the company had bought back shares at an average price of 11.30 from 1955 to 1962. It's the changing thesis after which is puzzling. Contrary to Blue Chip Stamps, the capital redeployment was relatively low and delayed.

[boilermaker75]

This looks very interesting. But the value investor in me is going to wait till the Kindle version goes on sale!

 

Besides, I have more books in the queue than lifetime left, so I have plenty to read while I wait!

[Jurgis]

Besides, I have more books in the queue than lifetime left, so I have plenty to read while I wait!

 

Same problem here. Immortality could solve it. Or adding some parallel processing units.

 

 

(Amazon had a huge Kindle sale on Sunday, so my queue increased by way too many books.)

[Cigarbutt]

The section on Geico (purchase of a non-controlling interest in the late 70s) is interesting. From a valuation standpoint, apart from survival risk which was significant, the price paid was very compelling using reasonable assumptions (much lower premiums base, corporate tax rate at around 48% then etc). However, the investment was unusual from the risk perspective and required (apart from a deep understanding of financials and scenarios (run off of higher risk categories, extent of policy mispricing and reserve deficiency)) an unusual activist approach. Mr. Buffett's involvement with regulators (Mr. Wallach as a key intermediate for the transition) and assessment of Mr. Jack Byrne (who was instrumental in changing the underwriting culture on a dime (walking away from unprofitable business, 48%-type policy price hikes, massive licensing of personnel) and in securing additional financing from outside investors and the reinsurance bailout by other insurers (competitors)) are not really covered in the book. Geico was more than just a numbers story.

https://futureblind.com/2014/08/26/1976-buffett-letter-about-geico/

[gfp]

Thanks for the recommendation - just getting started on this book today.  First thing that I noticed is that Berkshire has essentially the same number of shares in 2020 as it did in 1960 - 60 years of net-zero issuance (thankfully for that 1961 share repurchase of 18,139 A-shares: worth $5.3 Billion today)

[Jurgis]

Thanks for the recommendation - just getting started on this book today.  First thing that I noticed is that Berkshire has essentially the same number of shares in 2020 as it did in 1960 - 60 years of net-zero issuance (thankfully for that 1961 share repurchase of 18,139 A-shares: worth $5.3 Billion today)

 

So BRK issuance of shares for acquisitions was totally covered by 1961 repurchase?

[gfp]

Thanks for the recommendation - just getting started on this book today.  First thing that I noticed is that Berkshire has essentially the same number of shares in 2020 as it did in 1960 - 60 years of net-zero issuance (thankfully for that 1961 share repurchase of 18,139 A-shares: worth $5.3 Billion today)

 

So BRK issuance of shares for acquisitions was totally covered by 1961 repurchase?

 

I'm only on the first chapter!

 

But yes - basically the 1961 repurchase of 18,139 shares (which would be called A-shares today) and the 44,351 A-share equivalents that have been repurchased since 2018 or whenever he started this modern repurchase activity.  Not bad Warren.  You can tell this is a guy who remembers what the share count was when he started this endeavor.

 

** edit - plus the shares bought since 2012, which didn't show up on my free ycharts graph.  He started with that $1.2 B deal from the estate of the guy who sold him flight safety or one of those acquisitions.  Its the dexter folks that really made out though...

 

So I guess the high for share count was about 1.651 million A-share equivalents in 2011 and since then he has brought it down to 1.6006 million A-share equivalents.  Or maybe a bit less if he has continued purchasing

[Morgan]

Thank you for the recommendation. I ordered it, read it, and enjoyed it.

 

If you have read other Buffett books and letters, you've read about all these investments before. That's ok though. This provided a different angle. That being said, all of the detailed financial info was very fun to review.

 

It was interesting to read about the problems he had trying to expand the insurance businesses (Home State).

 

Overall, a good book for Buffett junkies!

[wabuffo]

If y'all are enjoying this book and are financial data geeks like me, I have found just the thing that will complement your enjoyment. I know old letters of the Buffett Partnership Ltd/BRK annual reports from the 1960s and 70s have been floating around the internet for awhile now.  But what about the donut hole in the middle?  It's been impossible to find annual reports/10Ks from Blue Chip Stamps (ok, there's been some BCS letters but not detailed financials) or Diversified Retailing.... until now!

 

https://theoraclesclassroom.com/archives/

 

I found this site (The Oracle's Classroom) after reading the book and trying once again to use my google-fu to find something, ...anything on Blue Chip Stamps financials.  And then I found this site.  (I hope the COB&F moderator is ok with a link to another website - but it is Berkshire-related)

 

Now, I don't know if the author of the book co-ordinated with the owner of this website, but almost every footnote in the book referencing an old annual report, 10-K or even Moody's report from the old Berkshire network (Blue Chip, Diversified, etc) is available on this site.  Plus many more - I mean, old Scott Fetzer annual reports! Need I say more?

 

I am really enjoying reading (and analyzing) these old reports.  And I'm finding some new insights.

 

For example, I've always assumed that Buffett/Munger used the float of Blue Chip Stamps (via their investment assets in bonds, etc) and liquidated those assets to buy Sees Candy, Buffalo News, etc.  But instead, it appears they treated the stamp liability as pseudo-equity (instead of "debt") and leveraged up the balance sheet to buy Sees Candy using 100% debt (because the BCS capital structure had more 'equity' due to the stamp liability than GAAP portrayed).  Then they used the additional cash flows to pay down the debt quickly.  Its a subtle nuance, but I found it helpful in understanding how Buffett thinks about float and he operationalizes the use of it.

 

A big thank you to the owner of "The Oracle's Classroom" website and archives.  The site truly lives up to its name.

 

wabuffo

[DooDiligence]

If y'all are enjoying this book and are financial data geeks like me, I have found just the thing that will complement your enjoyment.  I know old letters of the Buffett Partnership Ltd/BRK annual reports from the 1960s and 70s have been floating around the internet for awhile now.  But what about the donut hole in the middle?  It's been impossible to find annual reports/10Ks from Blue Chip Stamps (ok, there's been some BCS letters but not detailed financials) or Diversified Retailing.... until now!

 

https://theoraclesclassroom.com/archives/

 

I found this site (The Oracle's Classroom) after reading the book and trying once again to use my google-fu to find something, ...anything on Blue Chip Stamps financials.  And then I found this site.  (I hope the COB&F moderator is ok with a link to another website - but it is Berkshire-related)

 

Now, I don't know if the author of the book co-ordinated with the owner of this website, but almost every footnote in the book referencing an old annual report, 10-K or even Moody's report from the old Berkshire network (Blue Chip, Diversified, etc) is available on this site.  Plus many more - I mean, old Scott Fetzer annual reports! Need I say more?

 

I am really enjoying reading (and analyzing) these old reports.  And I'm finding some new insights.

 

For example, I've always assumed that Buffett/Munger used the float of Blue Chip Stamps (via their investment assets in bonds, etc) and liquidated those assets to buy Sees Candy, Buffalo News, etc.  But instead, it appears they treated the stamp liability as pseudo-equity (instead of "debt") and leveraged up the balance sheet to buy Sees Candy using 100% debt (because the BCS capital structure had more 'equity' due to the stamp liability than GAAP portrayed).  Then they used the additional cash flows to pay down the debt quickly.  Its a subtle nuance, but I found it helpful in understanding how Buffett thinks about float and he operationalizes the use of it.

 

A big thank you to the owner of "The Oracle's Classroom" website and archives.  The site truly lives up to its name.

 

wabuffo

 

Oh my, this is interesting, thanks!

[Morgan]

If y'all are enjoying this book and are financial data geeks like me, I have found just the thing that will complement your enjoyment. I know old letters of the Buffett Partnership Ltd/BRK annual reports from the 1960s and 70s have been floating around the internet for awhile now.  But what about the donut hole in the middle?  It's been impossible to find annual reports/10Ks from Blue Chip Stamps (ok, there's been some BCS letters but not detailed financials) or Diversified Retailing.... until now!

 

https://theoraclesclassroom.com/archives/

 

I found this site (The Oracle's Classroom) after reading the book and trying once again to use my google-fu to find something, ...anything on Blue Chip Stamps financials.  And then I found this site.  (I hope the COB&F moderator is ok with a link to another website - but it is Berkshire-related)

 

Now, I don't know if the author of the book co-ordinated with the owner of this website, but almost every footnote in the book referencing an old annual report, 10-K or even Moody's report from the old Berkshire network (Blue Chip, Diversified, etc) is available on this site.  Plus many more - I mean, old Scott Fetzer annual reports! Need I say more?

 

I am really enjoying reading (and analyzing) these old reports.  And I'm finding some new insights.

 

For example, I've always assumed that Buffett/Munger used the float of Blue Chip Stamps (via their investment assets in bonds, etc) and liquidated those assets to buy Sees Candy, Buffalo News, etc.  But instead, it appears they treated the stamp liability as pseudo-equity (instead of "debt") and leveraged up the balance sheet to buy Sees Candy using 100% debt (because the BCS capital structure had more 'equity' due to the stamp liability than GAAP portrayed).  Then they used the additional cash flows to pay down the debt quickly.  Its a subtle nuance, but I found it helpful in understanding how Buffett thinks about float and he operationalizes the use of it.

 

A big thank you to the owner of "The Oracle's Classroom" website and archives.  The site truly lives up to its name.

 

wabuffo

u

 

 

Excellent link to site. Thanks!

[gfp]

Great book and great source material website link - thanks for the heads up on both.

 

One correction to my earlier posts in this thread about share count - The share count of Berkshire went from 1.6 million down to about 1 million in the early years of Warren's control.  Then there were various mergers to clean up the structure, including Blue Chip, Diversified Retailing, and eventually Wesco much later.

 

But Warren has returned BRK to the 1961 share count of 1.6 million A share equivalents.  Another 600k A shares to get us back to a million!

[Cigarbutt]

@wabuffo

i just finished the book. Thanks again. It is a rapid read and helps to connect dots.

-----

The idea is to look at specific businesses but isn't reasonable to look at the overall context? Let me contaminate 'your' thread with a 'macro' consideration (no politics, i promise) which resulted from an insight that permeated at the end of the book. The author shows that, for the period from 1965 to 1980, BRK performance (BV, IV, MV) had significant competition from 'gold' although most other participants did get swindled. FWIW, i agree with your conclusion about inflation pressures but it's not clear how we'll get there. Presently, when this question comes up along a target assessment, the most likely scenario chosen implies a J-shaped direction: negative rates as a low-level springboard for (much?) higher rates. Why? The last time an external shock caused such an accentuation in global fiscal deficits was during WW2. Mr. Buffett often quips that he bought his first stock in 1942 and suggests that the environment was favorable, when he says his father told him after that the market went up 2% that specific day. But this was shortly after Pearl Harbor and then stocks had lost about 30 to 40% since the highs reached in 1938. In many ways (historical anyways), stocks then were the cheapest ever. Still, in 1943, the budget deficit was 2.7x the NYSE capitalization. It was also a period when the Fed used asset swap techniques to transform fixed-income securities into the equivalent of cash. Still, this would have been a very poor time to hold gold.

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Now i need to find time to study the Archives that you submitted recently.