Sunday, November 9, 2008

The Warren Buffett Way: Chp 5 Part 2: Permanent Holdings

The Washington Post:

The Washington Post is a media company owning television stations and interests in several other newspapers at the time Buffett made his first purchase in the company in 1973. Buffett felt that the Washington Post had favorable long term prospects. In 1984, he wrote that the economics of a dominant newspaper business are among the very best in the world.

Buffett had four years of hands-on-experience with the Omaha Sun newspaper, prior to owning any Washington Post shares. This experience taught him about the business dynamics of a newspaper company. Therefore, investing in the Washington Post fell within Warren's circle of competence.

The Washington Post had been reporting great operating performance numbers for years before Bufett made any purchase in the company. In 1973, the market value of the Washington Post was $80 million. Buffet wrote that most security analysts would have estimated the intrinsic worth of the company to be around $400 million to $500 million dollars. Buffett purchased around $10 million worth of the Washington Post's stock in 1973.

Buffett believed that the capital expenditures of a newspaper would equal the depreciation and amortization charges over time. Therefore, the Washington Post's owner earnings would simply be the sustainable net income for the company. Net income for the Washington Post was $13.3 million in 1973. Dividing this by the long-term U.S. government bond rate of 6.81% would result in a valuation or around $196 million for the company, more than double the market cap at the time. Further adjustments to reflect an improvement in operating margins back to the business cycle average and a 3% growth rate reflecting the ability raise real prices into the future, would result in an intrinsic value of the company closer to $485 million. Therefore, there was a suitable margin of safety when Warren made his first purchase in the Washington Post company.

The management at the Washington Post acted in a very shareholder friendly way. Warren was a company director and schooled key management on the value of acting in the shareholders best interests. Management bought back large quantities of the company's stock at low prices, reduced expenses and effectively confronted the relevant labour unions. In essence, management took the necessary actions to increase the value of the business.

At the time Buffett made the purchase in the Washington post, the return on equity for the company was around 15.7%. Within 5 years, the return on equity had more than doubled while company debt had been reduced. When Buffett made the purchase, the market value of the company was $80 million, in 1992, this figure had risen to $2.7 billion. For every dollar in retained earnings, $1.81 was created in market value over this period.

The Washington Post earned the status of a permanent holding of Berkshire Hathaway.

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