Testing – Page 11

Apple: For What It’s Worth, Part II

Post author By jeff matthews
Post date November 7, 2011
14 Comments on Apple: For What It’s Worth, Part II

“All I said was I liked the pen…”

—Jerry Seinfeld, “The Astronaut Pen”

We considered naming this follow-up to last month’s “Apple: For What It’s Worth” column after a different song than the Stephen Stills classic—something more current, more relevant and just plain zippier…something, say, by the Arctic Monkeys (which, as long-time readers know, is the adopted house band for this virtual column).

And the Monkeys’ “D is for Dangerous” would have certainly fit, because, as it turned out, we were treading on dangerous turf merely by pointing out one interesting bit of data regarding Apple that was not going—as all things Apple have been going—“up and to the right,” to use one of Wall Street’s Finest favorite expressions.

Specifically, we highlighted the fascinating, abrupt slowdown in last quarter’s sales growth at Apple’s retail stores, along with the (literally unprecedented, for Apple) year-over-year decline in profits from those stores, plus the fact that not one of Wall Street’s Finest asked a question about either of those facts on the subsequent earnings call (no surprise there, really).

Turns out we probably should have stuck with the good stuff—like pointing out that our August 2010 prediction, reported here, that iPad sales could hit 50 million a year shortly (at a time when Wall Street’s Finest were saying 15-20 million for 2012), looks on target: the 2011 calendar year number should be 40 million; 2012 north of 50 million.

But we did not point out the great iPad sales, because, after all, everybody knows how well the iPad is doing—although there’s something interesting in the Amazon.com tablet rankings…well, never mind about that—and the modest blemish of a shortfall in the retail channel seemed far more interesting from an analytic point of view: we’d never seen numbers shift so quickly at a high-quality retailer.

The reaction here was swift and, in most cases, harsh—mainly along the lines of “Everybody knows Apple missed sales because everybody was waiting for the new iPhone and Tim Cook said so and you don’t get it and who are you to say Apple is falling apart…”

The whole thing called to mind the Seinfeld “Astronaut Pen” episode, when Jerry admires his father’s neighbor’s pen, “the kind the astronauts use” so the neighbor gives Jerry the pen but regrets it so much he later claims Jerry stole the pen, which causes a fistfight at a banquet given in Jerry’s father’s honor, and when Jerry is pushed to the microphone by his mother to calm things down, he finally pleads, “All I said was I like the pen…”

And all we said was, “Apple’s retail stores seem to be losing their mojo.” That’s all.

For the record, we’re big fans of the Apple stores—although initially, when the company began rolling them out in 2001, we would have put money on their being doomed to failure. Running a good retailer is a lot harder than it looks, and Dell had already been taking share from brick-and-mortar operators by going the opposite route—selling direct. In those days, the disintermediation of the Best Buys of the world seemed like a forgone conclusion.

But Apple’s retail stores are, in no way, shape or form, comparable to the Best Buys of the world.

Apple zeroed in on the customer experience like no other retailer since Nordstrom (see a really excellent history here), and as the product set grew from Macs to iPods to iPhones, and as Windows users became reacquainted with the Apple brand thanks to those non-computer products, the stores became Apple’s best weapon in shifting computer market share away from Microsoft: they provided fed-up but hesitant Windows PC users the ability to get comfortable with Macs in an environment that offered terrific, low-key help with no sales pressure.

Contrast the experience at an Apple store, where even grey-hairs wander inside to browse, check their emails or ask for help, with the experience at a Best Buy, whose business model has become so dependent on selling extended warrantees that a mildly non-tech-savvy consumer wouldn’t go inside to ask for help if they were being held hostage by a crazed gunman in the parking lot:

Best Buy Sales Salesperson: “Welcome to Best Buy! How may I help you?”

Hostage: “I’m being held hostage by this crazed gunman.” Best Buy Sales Salesperson: “Do you need an extended warranty on anything?”

Hostage: “No, I need you to call the police.”

Best Buy Salesperson: “I can’t help you there, but perhaps that crazed gunman next to you needs an extended warranty on his sawed-off shotgun?”

Crazed Gunman: “You sell extended warrantees on sawed-off shotguns?”

Best Buy Salesperson: “Certainly, it’s all part of our slogan, ‘Customer Centricity’!”

Hostage: “What do warrantees on sawed-off shotguns have to do with ‘Customer Centricity’?”

Best Buy Salesperson: “‘Customer Centricity’ is about carefully listening to the customer’s needs, evaluating the most relevant options to deal with those needs, and then selling him or her an extended warranty.”

Hostage: “I don’t need an extended warranty. I need the police.”

Best Buy Salesperson: “I can’t help you there, but I can explain the fake benefits of our extended shotgun warranty, which covers any make or model shotgun except those that have been fired, handled, pointed, dropped, dismantled, aimed, loaded, touched, looked at, rented, borrowed, purchased—”

Crazed Gunman, turning gun on himself: “I can’t take this anymore.”

Hostage, grabbing the gun: “Me first.”

Not for nothing Apple stores as small as 4,500 square feet of selling space with a handful of young, mild-mannered Apple enthusiasts outsell Best Buy stores with 45,000 square feet of fire-breathing, warranty-selling salespersons on the prowl.

How then to explain the sudden, one-quarter fall-off in sales growth at those stores? There are three reasonable explanations:

For starters, Apple has been warning for some time that extending its iPhone sales to telecom carriers around the world would affect the growth in Apple’s own retail store sales. And indeed, most iPhone users we know bought theirs at Verizon or AT&T, not directly with Apple. However, this channel saturation has been going on for a couple of years and wouldn’t explain the fall-off from a +36% sales gain to a mere 1% sales gain in one quarter’s time.

Second, as readers noted (and as spelled out in this chart-happy piece here), Apple’s sales were coming up against very tough comparisons thanks to the timing of past product launches when the iPhone 4S glitch occurred. While this is a reasonable mathematical explanation for part of the slower sales growth, it does not explain the sudden drop in profits: after all, difficult sales comparisons on their own don’t tend to lead to significant profit declines for retailers.

Third, as we noted in “For What It’s Worth”—and as many readers reminded us—Apple’s iPhone sales were stunted by as much as $1.5 billion last quarter as customers waited for the “iPhone 5” (expected by many to be the first LTE iPhone) which didn’t hit stores until October as the iPhone 4S. Indeed, we know several people who waited, and now own the 4S.

Still the impact on the retail stores from the delay does not alter the picture as much some might have thought. Apple’s retail stores comprise a bit more than 10% of total Apple sales, and it is a good bet that the stores sell a lower mix of iPhones (after all, you can buy an iPhone or iPad at Verizon and AT&T, but not a Mac).

Therefore, of the $1.5 billion in theoretical “lost sales” from consumers holding off for the iPhone 4S, a maximum of $150 million might have come through the stores. Add those deferred 4S sales back to the reported sales, and the meager 0.8% increase in year/year retail store sales becomes a 5% gain—which is, still, a significant fall-off from the 36% of the previous quarter.

Furthermore, the unheard-of 26% decline in store profits in the quarter would have only been reduced to a 15% drop, adjusting for the lost 4S profits. That’s still a record profit decline at the retail stores—even worse than the 12.8% drop during the heart of the financial crisis.

So, yes, we know Apple’s iPhone sales were up against difficult comparisons; yes we know Apple’s stores do volume that any retailer would kill for; yes we know Apple has the biggest share of smartphone gross profits; yes we know Apple is taking market share like you dream about; yes we know the retail stores are a small minority of the company’s overall sales; yes we know Apple is still growing faster than any peer, whatever the @%#@# some lousy #%$##@#@ says. (Indeed, we’ve had fun over the years highlighting Microsoft’s failed efforts to dent the iPhone juggernaut, here.)

But to a retail analyst, any abrupt slowdown—for whatever reason—matters. After all, no retailer—except, maybe, Sears—plans for a decline in profits. And we’d bet the decline in profits—as well as the flattening out of visitors to the Apple stores—was not in the company’s budget.

As for the current quarter, nobody should expect a further year/year slowdown in Apple retail store sales. For one thing, the 4S is making up for the lost sales right now; for another, there was the “buy one for Steve” mantra of many Apple faithful—including Apple co-founder Steve Wozniak, who was first in line at his local Apple store to buy a 4S as a show of support following Jobs’ October 5th death.

Furthermore, Apple just opened two more stores in China, and those are among the most productive retail stores in the world, for any retailer (estimates run well north of a quarter-billion in sales each, annually).

And if Apple, as expected, adds China Telecom to the mix…well, the retail store numbers should pick up, and pick up a lot.

So expect nothing but positive updates on Apple in these virtual pages, like the fact that in the last week of October of 2011, the iPad held 2 of the Top 10 tablet spots at Amazon.com, compared with 6 of the Top 10 tablet spots in the last week of October 2010.

Oh, wait a minute—that’s not actually positive, is it?

Nevermind…

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

The content contained in this blog represents only the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

NOTE ON COMMENTS: We abide by one rule on the comment pages here, and that is NO “Yahoo Message Board-Type Language.” So whatever you write and whether or not you agree or disagree with something, spell it correctly and keep it clean, and no personal stuff. And if you think we won’t enforce that, well, we have over 300 comments that never appeared because they were sloppy, obscene, or personal. —The Management

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Apple: For What It’s Worth

Post author By jeff matthews
Post date October 20, 2011
62 Comments on Apple: For What It’s Worth

Something’s happening here

What it is ain’t exactly clear

—Stephen Stills, “For What It’s Worth”

Something’s happening at Apple. We’re not sure what, but something’s happening.

Yes, everybody knows Apple’s quarterly earnings report disappointed Wall Street’s Finest. And yes, everybody knows Apple managed to calm the disappointed herd, mainly by using the phrase “we’re thrilled” seven times during the call while pointing out that the big miss in iPhone sales was likely due to everybody waiting around to buy the new iPhone 4S.

But not one of Wall Street’s Finest—not one—asked about the most disturbing pattern coming out of Apple’s earning release: the measly 1% year/year revenue increase at Apple’s retail stores, the 26% year/year profit decline at Apple’s retail stores, and the mere 4% year/year growth in visitors to Apple’s retail stores.

Certainly, there was an impact at the retail stores from the Apple Faithful waiting for the new iPhone. But even before this quarter’s jaw-dropping sequential-quarter momentum collapse from up 36% in June to up 1% in September—a downshift we can not recall seeing at any retailer, ever (please come up with one, and we’ll highlight it here)—the Apple retail stores had been losing their mojo.

For example, from the December 2009 to the June 2010 quarter, retail visits rose from 51 million to 61 million. This year, visits from December 2010 to June 2011 did not rise at all—from 76 million to 74 million.

Something’s happening here. What it is ain’t—exactly—clear.

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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Gawker Gets It Wrong: The Cancer Did It

Post author By jeff matthews
Post date October 14, 2011
4 Comments on Gawker Gets It Wrong: The Cancer Did It

Gawker, which is just one of the many excellent reasons the New York Times keeps cutting staff (I have yet to see an article “tweeted” or “liked” by anyone under the age of 30 from the Times) carried the following inflammatory story yesterday which zipped around the blogosphere faster than a Joe Biden expletive moment:

Harvard Cancer Expert: Steve Jobs Probably Doomed Himself With Alternative Medicine

Having established a provocative statement of purported fact in the title, Gawker’s unfortunate story led off with a howler of first sentence:

Steve Jobs had a mild form of cancer that is not usually fatal…

That statement is wrong. How wrong, we wrote about in 2008, here.

In fact, the five-year survival rate on the kind of “mild” islet cell tumor Steve Jobs had been diagnosed with in October 2003 is 42%. Mathematically, of course, that means the cancer is indeed usually fatal. And Steve Jobs survived seven years.

Now, a big part of the problem is that Apple as a company did the medical world—and the blogosphere—no favors by downplaying Jobs’ condition over the years. (And we wrote about that here.)

For example, when Jobs appeared at a conference in 2006 looking like, well, like a cancer patient, Apple actually said, “Steve’s health is robust and we have no idea where these rumors are coming from.” Two years later the company claimed Jobs had “a common bug.”

With all the disinformation spread about Jobs over the years, it is no wonder Gawker got it so wrong; but, having gotten it so wrong, they ought to get it right.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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Chatter—Mindless Chatter

There was “chatter” in the markets on Friday that Wells Fargo—the large US bank of which Berkshire Hathaway is the largest shareholder—was going to make a bid for Morgan Stanley, the currently beleaguered US investment that has been the subject of all kinds of rumors related to its financial health, so much so that last Thursday U.S. Treasury Secretary Geithner took it upon himself to declare there to be “absolutely” no chance of another Lehman Brothers-type collapse when asked at a Congressional hearing about Morgan Stanley.

How the chatter on Friday got started, we have no idea, nor did we bother to find out. After all, desperate investors start takeover rumors for the same reason desperate short-sellers start going-out-of-business rumors: to help their positions in a stock, however fleetingly.

The funny (or frustrating, depending on your point of view) side-effect of such “chatter” is that companies routinely call on authorities to investigate negative, stock-dropping, going-out-of-business-type rumors—Exhibit A being, of course, Lehman Brothers executives, who excoriated everybody but themselves prior to the collapse—but never call on the authorities to investigate positive, stock-boosting takeover rumors.

Along the latter lines, Exhibit A would be the investment bank formerly known as Bear Stearns. Prior to its 11th-hour rescue in early 2008 at the hands of the Feds and JP Morgan’s Jamie Dimon, Bear was the subject of too-many-to-count takeover rumors, starting at multiples of $100 per share in 2007 and stair-stepping down to a $30 per share rumor that went around the Friday before the Sunday of JP Morgan’s actual bid, which, as it turned out, was $2 a share (later upped to $10).

In any event, whether it was deliberate or delusional or merely daydreaming, somebody—we know not who, nor do we care—got the idea Friday morning that Wells Fargo was going to buy Morgan Stanley, and the rumor went around Wall Street even though it shouldn’t have, because anybody who knows the least bit about its largest shareholder, Warren Buffett, and his investment process (see here), would know that the idea makes no sense at all.

For one thing, there’s the “competitive moat” Buffett demands of his acquisition candidates, of which Morgan Stanley hasn’t exactly the widest, as the assets tend to ride up and down the elevator each day.

Then there’s Buffett’s eternal “make or buy” question when he evaluates a business: “How much money would I have to spend to replicate the business?” And it would be reasonable to think that Warren Buffett might expect that he and Wells Fargo—with assets in excess of $1 trillion—could, over time, replicate Morgan Stanley on an outlay of something far less than its current market capitalization of $27 billion.

So count us skeptical…and always amused at what new “chatter” awaits the markets, from whatever anxious shareholders are out there.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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Thanks, Steve: Of Apple and iPads, Not to Mention “Layla and Other Assorted Love Songs”

Post author By jeff matthews
Post date October 6, 2011
5 Comments on Thanks, Steve: Of Apple and iPads, Not to Mention “Layla and Other Assorted Love Songs”

NotMakingThisUp has produced a number of virtual columns over the years which, tangentially or directly, involved the creations, both physical and corporate, of Steve Jobs.

Those columns mainly, I admit, poked fun at Microsoft’s various attempts to duplicate the successes of its heretofore less successful technology competitor in areas such as music players, smartphones and operating systems.

But the last one, which followed a year-end Wall Street Journal column that struck a nerve, had nothing to do with Microsoft and everything to do with Steve’s last magic act: the iPad…not to mention an album by Eric Clapton and a friend named Paul.

By way of saying a heartfelt “Thank you” to the man (shown here)who made so much so possible to so many, we’re reprinting it below. — JM

Tuesday, December 28, 2010

But What Would Eric Think?

Brett Arends is steamed.

He’s had it up to here with the Cult of Apple, and he’s decided to do something about it: what he’s doing is he’s not getting an iPad for Christmas.

This is how the Wall Street Journal columnist began his pre-Christmas diatribe against the latest must-have invention from Steve Jobs’ North Pole Magic Factory:

Why I Don’t Want an iPad for Christmas

Everyone wants an iPad this Christmas, right?
Apple’s tablet computer is this year’s hottest adult toy. Sales are booming. James Cordwell, an analyst at Atlantic Securities, expects the company to sell six million this quarter, half of them here in the U.S. It’s driving the company toward what will probably be yet another blowout Christmas period.
But you can count me out. I don’t want an iPad for Christmas, thanks very much.
—Wall Street Journal, December 21, 2010

Arends’ reasons—there are ten in all, thus fulfilling the journalistic requirement for “Top Ten” lists at this time of year—include a few a rational ones (“The cost of the add-ons,” for one) and quite a few more irrational head-scratchers that, in the main, remind me of something Paul Hulleberg used to say.

Paul was a childhood best-friend, and a serious music-head in those days when serious music came on LPs (look it up, kids) packaged in fancy sleeves (look that up too, kids), which we would dissect along with the music (“Magical Mystery Tour,” with its 24-page color booklet, was a particular fave), debating everything from who-sang-what to what was the song about, anyway? (“Drugs,” we usually decided).

There was, however, one album from that period that we did not dissect.

It was “Layla” (technically “Layla and Other Assorted Love Songs”: look that up too, kids), courtesy of the post-Cream guitar hero Eric Clapton, but released under the assumed name of Derek and the Dominos.

Now, because Clapton’s name was not on the cover, and because the title song clocked in at seven minutes, the album failed to find an audience when it was first released, despite having both Duane Allman and Clapton playing together.

It was only a year later, when “Layla” was included on a Clapton ‘Greatest Hits’ compilation, that the year-old album became popular.

And therein lay the problem: Paul refused to buy “Layla and Other Assorted Love Songs” after the album became popular, because the whole point of us being music-heads was that we were supposed to find this kind of stuff before everybody else knew about it—not when Layla had become as close to a hit record as was possible on WNEW FM, which back then was the leading-edge New York music-head station, home to the likes of wispy-voiced Alison Steele (“The Nightbird”) and gravely-voiced Scott Muni.

“What would Eric think?” Paul would say. “I can’t buy it now that it’s popular.”

I’d throw an album cover at him and yell something like “Eric would say ‘Thank you for the five bucks.’”

My reaction, of course, made him say it every chance he got.

Which brings us back to Arends’ “Top-Ten” reasons not to buy an iPad: he seems less interested in what the thing actuallydoes—which is a lot—and more concerned about what itrepresents—which to him is a slavish devotion to the Cult of Apple.

Let’s take the first five of his so-called reasons:

1. It’ll be cheaper next year.
That may be true, but it may not be true. While the painfully slow first-generation iPhone soon became, as Arends writes, “a paperweight,” the iPad is no such thing: it is fast, easy to use, and excellent value for the money.

2. It’s going to be better next year.

“The next iPad will have new features—allegedly including video conferencing and maybe a better screen. This year’s model will be so over,” he writes. This may also be true—but it probably won’t, since not many people are a) sitting around waiting for video conferencing, and b) unhappy with the iPad’s gorgeous screen.

Unless Steve Jobs is going to attach a working personal jet-pack to the next generation iPad, it’s hard to see a reason the average user will care to wait.

3. Apple’s profit margins are too high.
This is the biggest head-scratcher. First, Arends gets the margins wrong. He cites Apple’s year-old 41% gross margin and says “Me, I don’t want to support someone else’s 60% markups with my own dollars.”

But Apple’s gross margins are now running at 37%, down significantly from last year thanks in no small part to the lower margins Apple gets on the iPad compared to the iPhone, the price of which is subsidized by the wireless phone carriers.

Second, the issue shouldn’t be what Apple’s margins are, unless, of course, like Microsoft’s margins they result from a monopolistic business model in which the consumer has no choice when seeking an Intel-compatible computer. The issue should be value-for-money.

And the iPad is terrific in that department.

4. Competitors are coming.
This is true, as far as it goes. Arends unfortunately cites the Samsung Galaxy Tab, which means he apparently has not seen a Galaxy Tab, nor used one, because the Galaxy Tab is the least of the iPad’s potential concerns, in our opinion. It has a surprisingly small screen, for starters; and based on hanging around the repair desk at Verizon stores, we are told the thing tends to seize up and need rebooting, which may explain why a friend’s 22 year old daughter recently called the Galaxy “an iPad for losers.”

5. No flash.
By this, Arends refers to Steve Jobs’ famous decision to leave Adobe’s Flash Player for video and animation off the iPad. This was a very a big issue when the iPad first came out, because most web sites used Flash at that point, and it was about the only thing competitors could talk the iPad down with.

But today, an increasing number of web sites (MLB, for example) that were Flash-only last spring now accommodate the iPad, and do so beautifully.

Of the remaining five issues on the list, one is merely list-expanding padding (“It’ll get boring”), while another regurgitates mainstream fluff (“The whole Apple cult is starting to creep me out”).

But what it all seems to come down to is, like Eric Clapton’s “Layla” those many years ago, the iPad has become too popular for some people to admit they want one.

Our own advice is, don’t listen to “Top-Ten” columnists, whatever newspaper they write for, and don’t listen to virtual columns like NotMakingThisUp: try it yourself and make up your own mind.

Meanwhile, I’ll have to call Paul and see if he’s got an iPad, or if he’s holding out like our Wall Street Journal columnist. Besides, it’ll give me a chance to find out if he ever, finally, bought “Layla and Other Assorted Love Songs,” too.

Paul had excellent taste: I’ll bet he’s got them both.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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Hero or Hypocrite? “The Buffett Rule” Then and Now

Post author By jeff matthews
Post date September 27, 2011
22 Comments on Hero or Hypocrite? “The Buffett Rule” Then and Now

“The first rule is not to lose. The second rule is not to forget the first rule.”

—Warren E. Buffett, quoted by Carol J. Loomis, Fortune Magazine, 1988

Having recently celebrated his 81st birthday, Warren Buffett is not going softly into that good night. He is, in fact, going quite noisily ahead, making new friends—and new enemies—along the way.

His most visible friend, of course, is President Obama, who has gone so far as to name a new tax proposal after him (“The Buffett Rule”), following the Oracle of Omaha’s August 14 op-ed piece in the New York Times calling for higher tax rates for the rich, as follows:

“I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more…I would suggest an additional increase in rate.”

Buffett’s most visible enemy, now that his long-submerged but never denied personal brand of liberal Democrat politics has burst, full blown, into the open, is a collection of bloggers, politicians, political commentators and billionaires taken to excoriating Buffett for his high-minded, highly visible, and, they say, highly misguided stance on tax policy.

The centerpiece of the criticism is pretty straightforward: if Buffett feels so strongly about paying higher tax rates in the interest of fairness, nothing is stopping him from setting the example by voluntarily cutting a bigger check to the U.S. Treasury.

Buffett’s comeback is, and always has been, likewise straightforward: he simply follows the rules, he says, and the rules currently tax his earnings from dividends and capital gains at a lower rate than regular income.

It’s the kind of by-the-book self-justification that drives those who see Buffett as a rank hypocrite out of their minds, and reassures those who see Buffett as a hero in the current policy wars.

All this is unfortunate, because Warren Buffett, Political Guy had, until yesterday’s unprecedented share-repurchase announcement, largely wiped from the public mind Warren Buffett, Investment Guy—the supremely rational, highly quotable steward of Berkshire Hathaway whose track record for the last four-plus decades is, in fact, unequaled.

How “unequaled” is Warren Buffett’s track record, you may ask? Well, he literally turned his own personal investment of $100—that’s one hundred dollars—into a current net worth of close to $40 billion (and $62 billion at its peak, before he started giving it away).

To see exactly how he accomplished that unequaled feat, you can read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” (available at Amazon.com, here)which explains in plain English what made Buffett the Investor unique while also exploring the upsides and downsides of his extremely risk-averse management style…but we’ll provide one big clue here.

That clue is the original “Buffett Rule,” quoted above, which had nothing to do with raising taxes on the wealthy and everything to do with investing, and is worth repeating:

“The first rule is not to lose. The second rule is not to forget the first rule.”

So well did Buffett adhere to this rule of investing that in his first 46 years managing Berkshire Hathaway’s investment portfolio, Buffett had exactly two losing years (the stock market had 11 in that time), thus allowing Berkshire’s net worth to compound at slightly over 20% a year—an astonishing rate of growth, never duplicated.

But it is a track record that is increasingly underappreciated, because the old “Buffett Rule,” about investing, has been replaced by a new one, about taxing the rich.

The irony here, for anyone who has studied Berkshire Hathaway and Warren Buffett, of course, is that Buffett is as savvy in the taxpaying department as he is in the investing department.

His recent, high profile $5 billion investment in Bank of America, for example, was structured to minimize taxes on the dividends Berkshire will receive (insurance companies can deduct a large portion of dividend income, unlike mere mortals). This drives some bloggers crazy, but the fact is, Warren Buffett, as CEO of a publicly traded company, would be remiss if he did not attempt to maximize the after-tax benefits of all Berkshire’s activities. Shareholders expect and deserve nothing less.

Besides, Warren Buffett himself has always recognized the benefits of paying taxes at lower rates—via the same kind of low capital gains rates he currently criticizes. Indeed, he long ago wrote to his own investors the following:

“I am an outspoken advocate of paying large amounts of income taxes – at low rates.”

—Warren E. Buffett, July 10, 1963

The quote is lifted, verbatim, from a letter Buffett wrote to investors in Buffett Partnership LTD (the hedge fund Buffett managed, prior to taking control of Berkshire Hathaway) and it was Buffett’s way of telling his investors that he would not make investment decisions based on the cost basis of stocks in the portfolio, but, rather “on the basis of the most probable compounding of after-tax net worth with minimum risk,” as he also wrote in that letter, which you can read here.

(We’ve read all of Buffett’s early partnership letters, at least those available on that wonderful tool, the Internet, as well as every one of his Berkshire Hathaway letters, and advise any aspiring investor to do so as well.)

Buffett thus early on identified the minimization of taxes as a key to maximizing long-term investment success, and knew the way to do that was to generate wealth through investments that were held long enough to be taxed at lower capital gains rates—a benefit “The Buffett Rule” would attempt to end—and anyone who has studied his methods knows this.

Unfortunate as the uproar caused by Warren Buffett, Political Guy, has been by blotting out the accomplishments of Warren Buffett, Investment Guy, said uproar is especially unfortunate because it comes at a time when Warren Buffett, Investment Guy, has been busy on many productive fronts.

The Bank of America investment—a no-lose deal in the classic Buffett vein—was just one front. Another was his recent selection of a second investment manager, Ted Weschler, of whom we’ve heard nothing but good things (“a great, smart, smart guy” in the words of a former co-worker). And a third front—yesterday’s share buyback announcement—is literally unprecedented in Buffett’s 46-plus years at the helm of Berkshire.

But the most unfortunate aspect of all, in our view, is this: the original, no-nonsense, invaluable “Buffett Rule” has been replaced, in many investors’ minds, by a new, politically-oriented (and therefore vaporous) “Buffett Rule.”

And that first Buffett Rule was one any investor, no matter what his or her politics might be, ought to have memorized.

So much so we’ll repeat it here, for old time’s sake:

“The first rule is not to lose. The second rule is not to forget the first rule.”

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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Ben Bernanke and “The Costanza Effect”

Post author By jeff matthews
Post date September 23, 2011
22 Comments on Ben Bernanke and “The Costanza Effect”

“This is found money. I want to parlay it. I wanna make a big score!”

—George Costanza, of Seinfeld, on interest income

We were having a back-and-forth via Twitter this morning with a friend of this blog, a very smart reporter who had taken issue with our non-economist-trained view that Ben Bernanke was not saving the U.S. economy by suppressing interest rates at near-zero levels: he was, rather, pushing the U.S. into a depression by killing the interest-rate spread on which the very banks that circulate the life-blood of the system live.

Interest rates, we argued, were not, as Bernanke has believed, too high for the good of the country, they were too low.

Logically, our friend responded that if credit were really as underpriced as we claimed, “Savers would surely use underpriced credit to snap up inflating assets and goods. They’re not.”

And he is right.

However, the reason savers are not jumping out of no-longer-interest-earnings savings accounts and into risky asset pools is not that rates have been too high. We think it is a function of the fact that, at a certain point, low interest rates become counter-productive: they make savers more cautious, not less. Interest rates are, we think, too low.

After all, if you’re not earning anything on the money you have in the bank, your instinct is not to take it down to the track and go bet the whole bundle on Greased Lightening, as Tony Curtis’ character did in “Some Like It Hot.”

No, you’re going to sit tight.

Now, this behavior probably has some fancy economist-type label, but we will hereby declare it to be a reverse-manifestation of “The Costanza Effect,” after George Costanza of Seinfeld fame.

In one episode, George, upon receiving notice of an old passbook savings account with accumulated interest, chooses not to keep the money in the bank, but to gamble it away.

George: “The State Controller’s Office tracks me down. The interest has accumulated to 1,900 dollars. 1,900 dollars! They’re sending me a check!”…

Jerry: “Why don’t you put it in the bank?”

George: “The bank? This is found money. I want to parlay it. I wanna make a big score.”

Jerry: “Oh, you mean you wanna lose it…”

We think “The Costanza Effect” illustrates that people are more willing to risk found money than earned money, and thereby explains precisely the Bernanke dilemma, whereby interest rates have dropped to zero and yet savers have reacted with exactly opposite the intended result.

Far from, as our friend wrote, “use underpriced credit to snap up inflating assets and goods”; they have chosen to sit on what they have.

Kramer for Fed Chairman, anyone?

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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UBS, Connecticut, and The Reverse Protection Syndicate Racket

Post author By jeff matthews
Post date September 18, 2011
4 Comments on UBS, Connecticut, and The Reverse Protection Syndicate Racket

I went back to Ohio

But my pretty countryside

Had been paved down the middle

By a government that had no pride…

I said, A, O, way to go Ohio

—Chrissie Hynde, The Pretenders

Well UBS is in the news again, this time for a “rogue trader” who spent three years losing $2 billion of UBS’s hard-earned money before UBS figured out the money was gone. Good thing the Swiss banking giant has friends in government to support it.

We’re thinking specifically of the State of Connecticut, our home state, which agreed to pay UBS $20 million to stick around Connecticut for five years.

That’s $20 million in cash the state’s taxpayers are paying to a company that just tossed $2 billion out the proverbial window.

Now, the reason Connecticut is paying UBS $20 million doesn’t strictly relate to the rogue trader, who was actually located in London: it’s because the state has become so unattractive to business that our governor has to pay companies to stay.

We are not making this up. Here’s how Reuters carried the story recently:

NEW YORK – UBS AG will receive a forgivable $20 million loan for deciding to stay in Stamford, Connecticut, for five years instead of moving some investment bankers to the World Trade Center complex in New York City…

“This project [emphasis added] will retain at least 2,000 high-quality, high-paying jobs in the state, spur capital investment and reaffirm the state’s reputation as a leader in financial services,” Connecticut’s Democrat Governor Dannel Malloy and UBS Group Americas Chief Executive Officer Phil Lofts said in a joint statement.

Now, this is the first time we have heard a bribe described as a “project.” But never mind that quibble: we have a bigger one: calling it a “loan.”

After all, the term “loan,” when preceded by the adjective “forgivable,” renders the thing not a loan, but a flat-out contribution, because if you think UBS has any intention of paying back a forgivable “loan,” you are either a good-government type who firmly believes that the machinations of local politicians are intended to produce something higher and more useful than gainful long-term revenue for those politicians and their friends, or you haven’t talked to an actual businessperson who has received such a “forgivable” loan.

We have talked to actual businesspersons who’ve gotten forgivable “loans” similar to the UBS deal, and those “loans” are not viewed as “loans” by actual businesspersons, they’re viewed as capital that has been invested in their business in return for short-term promises—such as not moving that business to another state or another country for a certain period of time.

And while UBS will, we have no doubt, honor the terms of the “loan,” UBS will also, we expect, do nothing above and beyond the specifics of the deal. Nor will it pay back the $20 million—especially now that the firm just lost the equivalent of one hundred $20 million investments at the hands of a trader who, bright though he may be, looks like he just got out of high school.

Furthermore, the $20 million contribution by Connecticut taxpayers to UBS’s pockets will certainly not “spur capital investment” in the state, since any business that was planning to invest capital in Connecticut will see straight through this sort of Reverse Protection Syndicate Racket (in which companies are not coerced into making payments for protection, but are paid to be protected) and ask themselves, and their elected officials, what cash can be extracted in return for threats to leave.

Nor do we see how it will it “reaffirm the state’s reputation as a leader in financial services,” since the deal made it clear to the world the only reason UBS agreed to stay in Connecticut for another 60 months was that the governor paid it to stay.

In fact, Connecticut’s “reputation” is less “as a leader” and more “as a hard place to do business.” It ranks 47th in the Tax Foundation’s State Business Tax Climate Index; carries the third highest per-capita tax burden of the 50 states; and is notorious for making local businesses wonder why they bother…so much so that UBS was, at the time of its “loan,” preparing to flee Connecticut for New York, which is not much less difficult, business-running-wise.

Nevertheless, Connecticut must be getting something for its $20 million “forgivable loan” to UBS, and indeed, according to the governor, Connecticut will preserve, for the five years of the deal, as much as $70 million a year in tax revenue that could have been lost if UBS had left the state.

Now, probably that figure is an exaggeration. Back-of-the envelope calculations of income taxes, sales taxes and corporate taxes attributable to 2,000 high-earning UBS employees max out at closer to $50 million, even using generous assumptions.

But, so what, you say? Spending $20 million over five years to save even $50 million annually sounds like a good “return on investment.”

The problem is, that is not an investment. It is a bribe—a form of reverse protection in which businesses that threaten to leave the area receive cash collected from individuals and businesses that don’t threaten to leave.

As such, it is impermanent, subject to political pressure and favoritism, and short-term in nature. Worst of all, these Reverse Protection Syndicate deals don’t lower the cost of doing business in the state: they raise the cost for all the other businesses.

It’s no wonder that Connecticut has lost half its manufacturing jobs in the last 20 years, and has had no net job growth in that time. And if the UBS deal is any indication, the bleeding in service jobs has just begun.

A, O, way to go…Connecticut.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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9/11

It doesn’t matter, but here’s my story.

I was swimming laps in the pool in the Ritz-Carlton in San Francisco, and thinking tech stocks, when the first plane hit. I didn’t know what had happened until I came out of the men’s locker room around 6 a.m. PST and somebody—somebody in the hallway—said a plane had hit the World Trade Center.

There was a Bloomberg terminal nearby—this was a tech conference, and the hotel was full of Bloombergs—and checking the top stories, sure enough, a plane had hit the towers.

So I got in the elevator with another guy and we speculated about whether an airline was involved—with not a thought about the human tragedy—because the mentality of this business, sick as it can be, is to calculate how a given event will affect a given stock. And all we knew was a plane had hit the towers, and the first word was it was a small plane.

When I got in my room and turned on the TV, the second plane had hit. So of course everything changed, and I decided to leave. Since they’d closed the airports, this meant driving cross-country. No big deal—I’d had dinner the night before with a bunch of friends, some from the New York area. We’d drive together.

The strangest part came next: leaving my hotel room (it was maybe 6:30 a.m., California time) to walk to the lobby, I saw nobody else—only the newspapers hanging on all the doorknobs—and so I thought, “Am I over-reacting? Am I the only person here who thinks this is as bad as it is?”

I decided I wasn’t. I’d worked at One Liberty Plaza, across the street from the towers, early in my career, I’d been to meetings at Windows on the World, I’d watched the tall ships from offices in the towers, shown our two daughters the view from those floor-to-ceiling windows. I had to get home.

The hotel lobby was weirdly quiet. I went to the concierge, told him I wanted to rent a car, he said “Certainly, where will you be returning it?” I said “Connecticut,” and he didn’t bat an eye. I waited for him to call and book the car, and then made him make clear that the car was going to get to the hotel, and I was going to get the car no matter what. Then I checked out.

I packed while calling people to tell them I was driving. At the same time I realized I didn’t know where anybody else was staying in San Francisco, so I’d be driving alone. A West Coast trader trying to be helpful told me the market opening would probably be delayed, and I told him he his was out of his mind and this was the worst thing to happen in our lifetimes and the markets wouldn’t open for a week, and I was going to drive home…but I used really bad language.

I left the room and now the hotel lobby was pandemonium, total pandemonium, hotel people rushing around, phones ringing, people talking. A young woman was on her cell phone trying to locate a friend who worked in the towers. I regretted checking out before the car arrived, because there was a line at the concierge desk of people trying to get cars, and the phones at the front desk were now going crazy—people stuck in town by the flight cancellations were looking for rooms.

Waiting for the car, I talked to my wife, our older daughter, friends, while young men and women from the conference huddled together, discussing whether to cancel the day’s events. I couldn’t believe they even thought what they decided would matter: everything was over.

Then the car came—but I remembered Bella.

Bella was my pal who worked in the gift shop. I went in to say goodbye to her: I was driving home. She said, “Do you have water?” I said no. “You need some water,” she said, and went into the back room to get me a bottle of water. It seemed important that day to help others: it was somehow up to her to give me something for the trip. She returned with a bottle and pushed it in my hands, and I gave her a hug and left, got in the car, drove down California Street, turned right and got on Route 80 East and went home.

I drove all day, from darkness to darkness, for three days and never watched TV and never saw anyone I knew. What I heard about 9/11 came from listening to a.m. radio and hearing Rudy Giuliani’s voice, and from calling friends during the day. I bought local newspapers at every stop along the way. There were American flags across every overpass. People were polite, kind, eager to make contact. The drive was easy: nobody tried to cut you off, nobody honked.

On Friday I pulled off Route 80 somewhere in New Jersey, and went to a church for the noon service that was being held everywhere at that time. And that’s when I really saw what it meant: the church was packed, and when the priest called for names to pray for, the names went on and on and on. A woman in front of me who reminded my of my mother-in-law called out, in an anxious, quavering voice, two names, “Ken and Dan.”

A couple hours later I pulled into my office and then stopped by the Greek diner next door to see how everyone there was doing. A friend was standing at the cash register, waiting to pay. Just by the expression on his face he was devastated. I said, “Ed, who did you lose?” He said, “Jeff, we lost our whole New York office.”

When I think of that week, I think of Bella pushing the bottle of water into my hands, of the young woman trying to track down her friend by cell phone from a hotel lobby in San Francisco, of Ed’s face, and of “Ken and Dan.”
God bless them all.

JM
9/11/11

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Major Major Major Major: A Book Love Story

Post author By jeff matthews
Post date September 5, 2011
7 Comments on Major Major Major Major: A Book Love Story

The laziest column being written in the Mainstream Press these days has to be the “Even Though I Own a Kindle/iPad/Nook I Still Like Print Books Better” lament.

Generally written by an aging Baby Boomer, the columns always start with a nod to the convenience of eBooks and the wonder of having thousands of different eBooks at hand with the tap of a button at all times (“I’m with it, I’m hip,” you can hear Dr. Evil insisting).

Having established “street cred” the columnist then moves on to lament the loss of the tactile nature of a paper book being held in one’s hands; the inability to dog-ear pages and underline sacred passages; and, most of all, to reclaim the time and “space” (a revoltingly overused word in these things) the reader occupied when he or she first discovered a particular book, because digital books don’t possess the nostalgic combination of visual and olfactory clues that paper books provide.

“It was ’63 and I was reading On The Road…” is how the last sentence usually begins.

Teeth-grinding and unpersuasive they may be, but these columns are so prevalent that a conspiracy theorist might suspect a concerted rear-guard effort by the doomed printing industry to create a counter-trend among us Baby Boomers’ children and grand-children such that old-fashioned books appear cooler/hipper/trendier/more worthwhile than the electronic kind.

And while I do read the print version of the Wall Street Journal cover-to-cover for the serendipity of finding interesting stories that can be overlooked on the Journal’s iPad app, and have, in fact, published an actual old-fashioned print book, the “Why I Still Love Print Books” stuff strikes me as more like the grumpy manifestation of a certain demographic seeing their lives flash before their eyes than anything else.

After all, the digitization of words is, to our times, what Gutenberg’s printing press was in his times: a radical reduction in the cost of shared knowledge.

That’s because the printed book business has to be—and this is from experience, not casual observation—the least efficient form of production ever created outside Soviet Russia.

Here’s how print book publishing works in the real world:

1. A book publisher bets on a bunch of books in the form of advances to various authors whose book proposals have passed muster: the bigger the advance, the more confident the publisher is in the ultimate payoff—the distorting effects of which will be felt at the time of publication, for reasons that will be made clear later on here;

2. The authors set about writing their books, with the help of editors, meeting or missing various deadlines along the way;

3. Meantime, the book covers must be printed because the publisher has to line up production slots ahead of time, so even though the books are not finished, and in some cases are not even mostly written, blurbs praising the books must be obtained (think about that next time you read a blurb on a brand new book);

4. All during this phase, the publisher’s sales force is running around trying to interest various book sellers in its books based mainly on the authors’ reputations and short summaries of what the books will say, none of which matters anyway because none of the book sellers can take risks on a book whose author they never heard of;

5. The books continue to take shape through a series of edits and corrections, none of which will prevent mistakes or typos from getting into the final printed copies because of the back-and-forth nature of the work;

6. The book is finished, but a year or more has gone by, and publishers discover that the world has changed: stuff has happened, national moods have changed…and while you would think publishers would adjust marketing plans based on which books now seem more timely than they did a year ago, the fact is publishers hate to do that because they are mainly interested in recouping the advances they already paid to the authors (the larger the advance, the more marketing the book will get, no matter what); thus the books will be published and marketed based mainly on the basis of how much of a sunk cost each book represents;

7. The books are printed, the covers are added, and the finished product is boxed and shipped to stores based on orders that have no bearing on the likely demand for the books given the swings in national moods, current events etc.;

8. Oh, and the books, which have been printed after a maddening series of corrections and edits, nearly always have typos and errors in the final copy anyway.

That’s just the way it works. It’s amazing great books by then-unknown authors (classics like Catch-22 and A Confederacy of Dunces, to name just two that almost never saw the light of day) ever make it into the hands of a single reader.

Now, this is not a criticism of the individuals involved in the book publishing industry. For one thing, they universally love language, and they know good writing when they see it.

And they really, really love books—printed books. They care about what the cover looks like, how the text appears on the page, and what the final product feels like in their hands.

But their business model is the functional equivalent of going down to the track and placing bets on a bunch of horses that won’t race for a year, in track conditions that nobody can imagine yet. (In fact, it’s more like placing bets on horses that haven’t even been born, because most advances are paid before the books have actually been written.)

So along comes the eBook model, which not only democratizes the demand for books by making them available to anybody with an Internet connection, but also democratizes the supply by lowering the cost of production and speed to market.

In fact, an eBook (a good one, on a meaningful topic—not one of those “Death of a Legend” hurry-up books that get churned out after some Hollywood star gets killed by a drug overdose) can be conceived, written, edited and published—mistake free, because it costs nothing to correct the text—in one tenth of the time, start to finish, of an equivalent print book, merely by reducing the friction of the printed book process.

So, yes, I’ve kept the old blue paperback English Lit 101 copy of Catch-22, which I re-read every few years just to get to the Major Major Major Major bit (“I have named the boy ‘Caleb,’ in accordance with your wishes…”) not to mention a cool, thin, beautiful Great Gatsby and a fat, funny Confederacy of Dunces, plus my first Thurbers and all those Dave Barry collections.

But I have ‘em all on the iPad, too, just in case I want to read one of them, wherever I happen to be.
I love books, period.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com