Berkshire's Annual Meeting Was Different This Time, In More Ways Than One...

May 2, 2016

In this issue:
» The rising disconnect between dividends and profits of Indian companies
» Should Public Sector Banks merge?
» Market roundup
» ...and more!
Richa Agarwal, Research analyst

Last Saturday, history was made for investors around the world. The date, 30 April 2016, was marked on our calendar for many months. Hailed as the Woodstock for Capitalists, Berkshire Hathaway's annual general meeting in Omaha is always highly anticipated. But this year's event was unique, historic even...

For the first time ever, investors around the world could 'attend' the event via live stream. It was indeed a special weekend as two of the best brains in investing, Warren Buffett and Charlie Munger, communicated live to millions value investors around the world.

While it's impossible to adequately wrap up the five-and-a-half-hour event in five minutes, here are some highlights for you:

  • Berkshire doesn't have budgets at the headquarters level and never provides guidance on earnings. The goal is simply to create 'sustainable' earnings power.

    With earnings season is upon us, I feel this is one of the most relevant revelations from the event. Many companies are yet to report financial results. Yet, claims that corporate earnings are on the path to recovery have already been made. With good results, guidance too is likely to be optimistic, with managements harping on better growth prospects ahead. And we won't be surprised to see markets surge on some positive guidance.

    However, we suggest you shift your focus from quarterly and yearly earnings to sustainable earnings. My colleague Rahul Shah recently wrote on why we expect earnings to jump around 70% over next two three years , leading to a similar gain in Sensex. However, only a few companies will ride the crest. At Equitymaster, through our bottom up stock selection, our goal is to filter out those stocks for you.
  • Size is the enemy of performance.

    Buffett was asked during the event why he was acquiring capital-intensive companies rather than firms that throw capital, as he did in the past. His answer was - a problem of prosperity.

    In other words, the curse of size for Berkshire. Small companies that don't require capital cannot offer enough returns to a firm as big as Berkshire is now. This explains why Buffett's career returns have gone from sensational to satisfactory.

    We have not stumbled on this block yet...and are unlikely to.

    We serve retail investors. Hidden Treasure is privileged to recommend stocks from the small-cap space, where the returns have been sensational.

Changing times, changing philosophies

  • Invest in a business any fool can run, because someday a fool will.

  • If there is one Buffettism that the Hidden Treasure team could never take seriously, it was the one stated above. Management meetings are a must for any small-cap stock we recommend. No matter how good the numbers and story look, if we are not convinced about the management quality, the stock never makes the cut.

    The economic and corporate landscape is changing fast. The world is getting more competitive. Businesses that will sustain in the absence of a competent management are rare birds.

    Buffett recognized the flaw in one of his favorite investing rules of old. His focus is now on good managements.

    When quizzed about why he went for Precision Castparts, Buffett said, 'It's very important that you have somebody there that has enormous skill .... Their reputation among aircraft absolutely unparalleled.'

    And this is what Charlie Munger had to say about PCC acquisition

    • A business like Precision Castparts requires a very superior management that's going to stay superior for a long time. We gradually have done more and more of that, and it's simply amazing how well it works. I think that to some extent, we've gotten almost as good at picking superior managers as we were in the old days at picking the no-brainer businesses.

    Mind you - Precision Castparts (PCC), which makes parts for the aerospace industry, is Berkshire's biggest transaction ever. Buffett acquired it or a mind boggling US$37.2 billion - and raised many eye brows in the process. Standard & Poor's even put the conglomerate on review for paying a higher multiple.

    One of the main reasons Buffett bought PCC was its CEO, Mark Donegan, who took over in 2002. Since then, PCC has made timely acquisitions to fill gaps in its portfolio.

    Our latest Hidden Treasure recommendation bears some resemblance to Precision Castparts. It's a key vendor to the aerospace sector, offering the complete range of software services to this sector, and one of the very few firms in the world to have reached this level of expertise. It doesn't tie-up with other IT firms to win large end-to-end aerospace outsourcing deals, and thus scores over the 'big five' of Indian IT in this regard. It managed to achieve this by timely acquisitions (just like PCC) to boost margins and return on capital. Its free cash flows have grown 29.2% CAGR from FY09 to FY15.

    Where our recommendation differs significantly from the PCC deal, though, is that we recommended the stock at attractive valuations...

  • I could go on and on about the Berkshire Hathaway meeting, but I would like to conclude with a profound statement from Charlie Munger:

  • Our advantage is we know we don't understand it.

    He was speaking on the subject of interest rates in Japan, but the comment could well be applied to interest rates, oil prices, commodity cycles, and so on. Real knowledge is knowing one's limitations. As long as you operate within your circle of competence...and with enough margin of are likely to do well as investor.

What is the key take away for you from Berkshire 's annual general meeting? Let us know your comments or share your views in the Equitymaster Club.

3:00 Chart of the Day

Dividends are often an indication of healthy cash flows of the company. A high dividend payout ratio is perceived positively. Indeed, a high dividend yield could make a stock very attractive. Today's Chart of the day highlights the trend in the dividend payment by the Indian companies over the last five years.

Will Indian Companies Be Able to Maintain High Dividend Payouts?

As the chart suggests, Indian companies have steadily increased the dividend payouts. But it is also important for investors to look into additional details, before getting swayed away by high dividend payments. Some of these are...

Will the company sustain the dividend payments? Are the high payments a result of better cash generating capability of business? Are the companies' profits growing at a healthy pace?

As per an article in Business Standard, 144 companies that have announced full year FY16 (or CY 15) results will pay dividends worth Rs 611 billion, up 19.2% year on year. While that looks tempting, the sheen fades when you cast a glance at the combined net profit number that has grown at a mere 5.7% YoY. No wonder the payout ratio looks good, up from 19.3% in FY 11 to 43% in FY 16.

Despite poor earnings, India Inc. is being generous and doling out dividends. Some have even dipped into their cash reserves to fund these dividends.

And this has supported the valuations. But before you get lured by these dividends payouts and yields, do question the sustainability of the same.

Investing in a stock just based on the dividend numbers may not be good for the health of your overall portfolio. Companies with growing dividends might not necessarily be offering equally good promise when it comes to earnings growth. Consequently, such companies sooner or later may reduce high payouts. Some may fear an investors' backlash on to dividend cuts. And thus may continue to pay dividends at the cost of company's growth. None of such companies bode well for your portfolio returns.

Best dividend paying firms usually have a few things in common. These are solid underlying businesses, shareholder friendly managements and strong operating cash flows. Investors should pay attention to these factors and only then they should commit their money to any company. Do check out our Premium report - How to Earn 10-30% Returns Without Selling Your Stock to know the best way to select dividend multibaggers.


We are all aware of the bad debt crisis in Indian banks, especially public sector banks (PSBs). The Indian government owns twenty-seven listed public banks or PSBs. Merging some of these is currently being argued as a measure to restore their health.

But Vivek Kaul, editor of Vivek Kaul's Diary, has a different take on the issue. As per Mr. Kaul, the merger of two public sector banks will give a bigger inefficient bank. Do read this interesting article to know Vivek's views on this matter.


After opening the day on a negative note, the Indian indices continued to remain under pressure in the post noon trading session. Sectoral indices are trading on a negative note with stocks from the telecom, IT and banking sectors bearing the maximum brunt. At the time of writing, BSE Sensex was trading lower by 165 points (down 0.64%). On the other hand, stocks from mid-cap and small cap spaces are in demand. The BSE Mid Cap index is trading up by 0.9% while the BSE Small Cap index is trading up by 0.1%.

4:50 Today's Investing mantra

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst).

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