Brand Deterioration: What Doesn’t Show Up In The Numbers

Sardar Biglari, the Chairman of Biglari Holdings, has demonstrated an ability to execute an intelligent business strategy. Personally, I have been impressed with the turnaround he has orchestrated at Steak ‘N Shake. Before he purchased it, the brand was languishing even to the point that the possibility of bankruptcy could not be laughed off. If you went to Steak ‘N Shake in 2006, it would cost you $7 to $10.

The issue was that Steak ‘N Shake did have brand recognition, but it did not have brand strength pricing power at the $7 to $10 range. Just as a company’s management team can become enamored with its business and repurchase its own stock at any price, it can also overestimate the amount of pricing power that its brand has. Or it can become intoxicated with high profit margins on the retail price to customers compared to the ingredient cost.

Biglari’s … Read the rest of this article!

Should You Invest in Blue-Chip Cyclical Stocks?

When someone buys individual stocks, it seems to me that investing skill comes in three stages. You have that first stage where you struggle to dissociate changes in the price of a stock from changes in the enterprise that it represents. In the second stage, you’re not worried about Wal-Mart falling from $63 in 2008 to $46 in 2009 because you know that earnings are growing from $3.42 to $3.66 (with a dividend increase to boot) so you can tune out the noise and assess the health of the enterprise.

The third stage is the tricky one, where even the best will still make errors: trying to figure out which stocks are “value investments” when the price of a stock falls while earnings deteriorate. The purpose is trying to figure out whether the amount of the earnings impairment is less than the amount of stock price decline, as well as … Read the rest of this article!

The Downside of Berkshire Hathaway’s No Liability Insurance Policy

Mailbag question from a reader: “Tim, is there any downside to Berkshire’s policy of not covering the Directors with liability insurance against losses. This is something Warren Buffett occasionally brags about. What’s the downside? [rest of conversation redacted] -William.”

Warren Buffett is right to brag about the lack of insurance coverage Berkshire agents have regarding their stewardship of the firm. It is the most surefire way to avoid approving of things that you do not understand, and it invites caution towards those deals that appear lucrative at first glance but have some type of remote catastrophic risk attached (this is why Berkshire avoided an acquisition of Lehman Brothers for pennies on the dollar while Bank of America opened arms for Countrywide Financial).

But that’s not what you asked. The way I see it, there are two potential downsides to not carrying personal liability insurance for directors. The first theoretical downside … Read the rest of this article!

Pandora Is A Fundamentally Flawed Stock

One of the difficulties of evaluating firms in the nascent stage of business growth is trying to figure out the role that share dilution will have on returns. That is one of the reasons why I have never covered Pandora as an investment. It is committed to having a debt-free balance sheet, and has also lost money every year it’s been publicly traded. That combination leads to heavy share dilution: Pandora had 163 million units in 2011, and now has 215 million pieces of ownership claims (i.e. shares of stock). If you’re a long-term shareholder of Pandora, the consequence of Pandora’s delayed onset of profitability is that each share of Pandora will perpetually earn 31.9% less than would be the case if Pandora had been profitable in 2011.

This fact isn’t a deal-breaker. If a company has the possibility of earning such lucrative future profits that the returns would be … Read the rest of this article!

The Dividend Production Of A Single Exxon Share

Since 1977, Exxon has raised its dividend by 7.47% annually. This is a figure that can be a little bit misleading if you intuitively conclude that it tracks the earnings growth of the firm, as the Board of Directors decided in 1984 that a strategy dedicated equally to buybacks and dividends was in the best interest of shareholders. It’s served shareholders exceptionally well, as 6% annual growth from production expansion and commodity price increases has translated into over 9% earnings per share growth. Throw in the dividend, and Exxon shareholders have collected 13.12% annualized returns since 1977 (the results would be even better if dividend reinvestment were included, though they would be lower if held in a taxable account).

What I like about Exxon’s dividend is that it is the only firm where you can have over 95% certainty that the dividend won’t be cut, even in an extended period … Read the rest of this article!