Client Letter February 2001
I have been meaning to write on this subject for a long time. But something else has always come along to consume my time. A Recent read of the 2000 Costco Annual Report got me thinking about this subject again.
At the 1997 annual meeting Warren Buffett was discussing criteria for judging managers at businesses that he was considering for acquisition or investment. Warren Buffett said that above all else there was one paramount factor, the integrity of the individuals running company was an absolute prerequisite to any business relationship with Berkshire Hathaway.
Central to this was the honesty of the people he had to deal with. Warren Buffett wants managers that not only will tell the truth, but also will give him the bad news. Warren Buffett wants someone that will discuss the problems first. Someone that runs a company with out playing games with the numbers.
Some one from the audience asked, how do you know if a prospect has the proper attitude. Warren Buffett smiled and his wry smile and said something to the effect of “Well you can leave your lunch money on the desk and leave the office.” The line got a big laugh from the shareholders, as they contemplated this picture of a man worth 30 billion or so putting ten dollars at risk in order to save his investors hundreds of millions.
Maybe he was serious maybe he was not. Personally, I got the impression that he was talking somewhat metaphorically. Maybe he leaves a little money lying around or maybe he has system of tests that he applies to conduct of managers that he uses to judge how well an individual will use his shareholders money. This is Warren’s version of due diligence, one that does not require that he spend millions of dollars feeding the lawyers and accountants.
So what are Warren Buffett’s “Lunch Money Indicators”. I can only guess about his ideas, but it is not too difficult to think of corporate behavior that tells you something important about the character of the people running the business. I would like to suggest a few simple tests that we can use that will help us judge the integrity of the managers.
In the field of accounting there are a lot of lunch money indicators. I would suggest lumpy earnings, but in this day and age Warren Buffett may be the only CEO that can get away with lumpy earnings. Yet, it seems to me that earnings should be lumpy, life is not meant to be a smooth ride. So, when we see companies that always meet or exceed earnings estimates by a penny or two, I get the feeling that this has more to do with accounting artistry than it does with good management.
Anyway, I said that what got me started on this, was the Costco annual report. As I was reading, the thought occurred to me that the annual report is a good place to look for “Lunch Money indicators”. One Example:
- The number of color pictures in BRK annual report = Zero
- The number of color picture in Wesco annual report = Zero
- The number of color pictures in the Costco annual report = Zero
- The number of color pictures in the Disney annual report = 114
Can somebody run me a screen that will rate stocks by the number of color pictures in the annual report?
This is a test that tells you something about management. How interested are they pumping up the price of the stock. Are they owners or option holders? And it is just possible that if management is not willing to spend shareholders money to build a glossy image it may mean they want the stock price to track intrinsic value. (But then that really would be too much to hope for.)
Actually the Costco annual report looks as though it cost less than the Berkshire Hathaway annual report. I would suspect that Charlie had a hand in picking out the paper but the Wesco report used better paper. Not only is the paper cheap but most of it is filled with numbers. I am not saying that I am going to go out and by Costco because of the annual report, but does it tells us as shareholders something important about the people running the business?
I hope to write more on this subject in the future. Lunch money indicators are actions that reveal management character. Potential areas I want discuss are share buybacks, Outright ownership stock vs. stock options, Special accounting charges, the number of Mercedes in The parking lot, the number of corporate jet aircraft, etc.
Stock Market Comment
The underlying market environment continues to improve. I am not happy to see money flowing back into the tech sector, because it means some speculative fever continues to linger, but the areas of overvaluation continue to narrow and there are many opportunities to buy good small and mid cap stocks at reasonable prices.
The Federal Reserve has started to ease, and history teaches that this means it is time to get fully invested. The first few months after the FED starts to ease are one of very best times to make money in the stock market. The Slogan of the Month for February is “Don’t fight the FED”.
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