Did Warren Buffett make his most expensive mistake ever? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
PRINTER FRIENDLY | ARCHIVES

Did Warren Buffett make his most expensive mistake ever? 

A  A  A
In this issue:
» Fiscal adjustment at the cost of lower expense
» Growing incidence of these loans is worrisome for banks
» ...and more!


00:00
Smart investors always keep an eye on Warren Buffett's moves. He's one of the wealthiest men around. But that's just one reason. After all, he did not create all this wealth out of thin air. His investing acumen and ability to spot great businesses has set him apart from the rest.

Luckily for us, Buffett has not chosen to keep his investing secrets to himself. He shares them in his annual letters to shareholders - always a compulsive read for devout value investors.

So when Buffett's Berkshire Hathaway announced the acquisition of Precision Castparts Corp. a couple of days back, it raised a few eyebrows. Ours included. At US$32.4 billion, many consider this the company's largest acquisition in terms of value. But the key here is whether the price paid is right. At 21.2 times last year's profit, P/E valuations do seem high, which Buffett has acknowledged.

So has Buffett made his biggest investing mistake ever? Before we rush to judgment, given Buffett's success over the years, let's take a deeper look into his thinking and what prompted this move in the first place.

Let's start with the company itself. Precision Castparts makes nuts, bolts and other fittings for the aerospace industry. The company also derives some revenues from the oil and gas sector.

Weak oil prices have taken a toll on the oil industry in the US. Naturally, this has impacted Precision Castparts in the last few quarters.

But is that something to worry about? Buffett has always invested in companies for the long haul. So a few quarters of tepid growth is hardly something to bother him. And the practice of predicting oil prices in the short to medium term is futile at best.

What matters to him is the strength of the business. And the biggest clients for the company are in aerospace. This is what Buffett had to say in an interview with CNBC: "The aerospace industry needs them as they [Precision Castparts] are universally regarded as the most reliable, innovative and dependable supplier of very key parts that goes into all kinds of aircrafts."

Thus, as long as the aerospace industry exists (and there is no reason not to believe so), Precision Castparts will continue to have that competitive edge or the moat that so attracts Buffett. A few years of tepid growth, common in cyclical industries such as aerospace, won't deter him.

Furthermore, in addition to the strength of the business, Buffett values the quality of management. This, of course, cannot be measured in numbers. As the Wall Street Journal reports, Buffett appears to be impressed by the Castpart CEO's low-key profile, how cost conscious he is, and his passion for and deep involvement in the business.

So although the price Buffett paid for the company might seem slightly high now, his logic with respect to the strength of the business and management quality appears as sound as ever. But will this acquisition add considerable value to Berkshire in the longer term? Only time will tell.

Do you think that Warren Buffett paid too much for Precision? Let us know your comments or share your views in the Equitymaster Club.

--- Advertisement ---
Don't Miss Out On This Investment Potential...

High potential small caps are an investment segment ignored by many investors as they really don't understand it.

And we don't blame them at all.

This segment requires thorough analysis and research of the stocks...

They might even need to personally meet up with the managements to evaluate the business's potential before investing hard earned money

Fortunately, our highly skilled research analysts have been doing all this and more and guiding our subscribers to high potential small caps for more than 7 years now...

Their efforts have made our subscribers earn returns like 250% in 2 years, 110% in 2 years 4 months, 288% in 2 years and 5 months, 124% in just about 7 months and more.

Are you interested? Click here to know more...

------------------------------

02:46  Chart of the day
Government finances have been under strain in the last few years. This has resulted in rising fiscal deficit which is essentially the difference between government expenditure and non-debt receipts. Typically, growing economies fund high fiscal deficits through higher debt or borrowings. However excessive debt can push a country to bankruptcy in the event of an economic downturn as was the case with Greece recently. Therefore the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 had set out a target of three per cent of GDP for India by FY17. In FY15, the government has been able to bring down fiscal deficit to 3.99% of the GDP, lower than its revised estimate of 4.1% of the GDP. The fiscal consolidation road-map outlined in Union Budget 2015-16 proposes to bring down the fiscal deficit to 3.9% in FY16, 3.5% in FY17 and 3% in FY18.

There is no doubt that a lower fiscal deficit results in lower interest payments leaving more money in the hands of the government for welfare and development. However, the measures taken to reduce deficit has an important bearing on a country’s growth plans.

The fiscal consolidation exercise in the past has been driven by expenditure cuts by the government. The total government expenditure has reduced from 14.8% of GDP to in 2011-12 to 13% of GDP in 2014-15 (provisional). This in turn has led to lower capital expenditure over the years which can hamper the country’s efforts to fast-track its growth. Going ahead, the government has budgeted for a higher capital expenditure in FY16. Even lower crude prices will continue to help the government in reducing the expenditure on major subsidies and aid the fiscal consolidation exercise.

Fiscal adjustment at the cost of lower expense


03:48
Infrastructure financing by banks has its own set of problems. Rising bad loans in the banking system may not be over as yet. However, some public sector banks have reported lower slippages and a slight improvement in the gross non-performing assets in the June 2015 quarter. Largest public sector lender, State Bank of India saw a 6.6% YoY fall in gross non-performing assets during the quarter. Even the slippage ratio for the bank has come down to 2.1%.

But what is worrisome is the growing incidence of loans in the Special Mention Accounts-2 (SMA-2) of banks. Technically speaking, SMA-2 loans are loans where the repayment has been due for more than 60 days but below 90 days, after which the loan is classified as bad. Although a share of these loans may also be on account of habitual late payers, but a jump in these loans raises a red flag. This is on account of two reasons. Firstly, banks do not share this data. Secondly, with the government permitting banks to refinance infrastructure loans of 25 years tenure every five years, there is a possibility of banks continuing to suppress potential loan defaults under the guise of this scheme.

There is no doubt that infrastructure projects world over have long gestation periods before they start earning cash flows. And if India were to catapult among the fast growing nations, infrastructure financing is the need of the hour. However, it would do well if more transparency is brought in these schemes to make banks more proactive in improving loan recoveries and thereby reducing the pile-up of stressed assets plaguing the system.

04:30
A last word on real estate prices. Vivek Kaul, our colleague at Daily Reckoning, has recently published a new report where he takes a view that "real estate prices are headed down". We strongly recommend you read that report for it contains some of Vivek's best writings on real estate. To claim the report and get Vivek's Daily Reckoning issues where he continues to share updates on Real Estate among other things, just click here... (it's a one click sign up).

04:46
The Indian stock markets languished in the red today on the back of global cues especially related to China devaluing the Yuan. At the time of writing, the BSE-Sensex was trading down by around 178 points. Gains were largely seen in metal, oil & gas and auto stocks.

04:55  Today's investing mantra
"Don't buy a stock just because everyone hates it." - Warren Buffett.
Today's Premium Edition
Up 173% in two years, how does the ABB stock look today?
We discuss whether ABB India's fabulous rise in stock price has the fundamentals to back.
Read On...Get Access
Recent Articles:
How Unique Are the Companies You Invest In?
August 21, 2017
One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.
You've Heard of Timeless Books... Ever Heard of Timeless Stocks?
August 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
Why NOW Is the WORST Time for Index Investing
August 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)
August 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

Equitymaster requests your view! Post a comment on "Did Warren Buffett make his most expensive mistake ever?". Click here!

2 Responses to "Did Warren Buffett make his most expensive mistake ever?"

Ravindra

Aug 12, 2015

To say that Precision Castparts makes nuts and bolts is NUTS. It has a 50000 tons press, world's biggest and makes mainly pressed and other parts for mainly aerospace industry. The Company is a worthy successor to the World's famous and leading Forging Company of yesteryears Wyman Gordon (also existed in India earlier). As you are aware, aerospace industry is looking up and up and not down. Parts for oil rigs is only one part of the business and that too not ordinary nuts and bolts.

Like (1)

R.Prasanna Venkatesan

Aug 12, 2015

I am also cric of Waren, for his sleeping over top IT stocks like Google, Microsoft, etc.,stating that he does not understand the business.Ridiculous, he has a battery of top equity research geniuses around him, including Jain, but has woken up and bought IBM, when it is dying a slow death, losing both computer harware and software markets. this will be the biggest folly of Buffett, nt Precision .controls, a nut and bolt industry, tat serves, aircraft, defence and a variety of industries.But dividends, will not be very big, as competition from Korea, Japan, China, France and India, will give it a run for money..

Like (1)
  
Equitymaster requests your view! Post a comment on "Did Warren Buffett make his most expensive mistake ever?". Click here!

MOST POPULAR | ARCHIVES | TELL YOUR FRIENDS ABOUT THE 5 MINUTE WRAPUP | WRITE TO US

DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
INTRODUCTION:
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

BUSINESS ACTIVITY:
An independent research initiative, Equitymaster is committed to providing honest and unbiased views, opinions and recommendations on various investment opportunities across asset classes.

DISCIPLINARY HISTORY:
There are no outstanding litigations against the Company, it subsidiaries and its Directors.

GENERAL TERMS AND CONDITIONS FOR RESEARCH REPORT:
For the terms and conditions for research reports click here.

DETAILS OF ASSOCIATES:
Details of Associates are available here.

DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
  4. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
DISCLOSURE WITH REGARDS TO RECEIPT OF COMPENSATION:
  1. Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
  2. Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
  3. Neither Equitymaster nor it's Associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  4. Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  5. Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
GENERAL DISCLOSURES:
  1. The Research Analyst has not served as an officer, director or employee of the subject company.
  2. Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
Feedback:
If you have any feedback or query or wish to report a matter, please do not hesitate to write to us.

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407