Interview With Bruce Greenwald On The Future Of Value Investing, Warren Buffett’s Purchase Of Burlington Northern, And More
Me with Bruce Greenwald
Bruce Greenwald’s bio from the Columbia Business School’s website.
Professor Bruce C. N. Greenwald holds the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School and is the academic Director of the Heilbrunn Center for Graham & Dodd Investing. Described by the New York Times as “a guru to Wall Street’s gurus,” Greenwald is an authority on value investing with additional expertise in productivity and the economics of information.
Greenwald has been recognized for his outstanding teaching abilities. He has been the recipient of numerous awards, including the Columbia University Presidential Teaching Award which honors the best of Columbia’s teachers for maintaining the University’s longstanding reputation for educational excellence. His classes are consistently oversubscribed, with more than 650 students taking his courses every year in subjects such as Value Investing, Economics of Strategic Behavior, Globalization of Markets, and Strategic Management of Media.
I would like to add that Bruce Greenwald has authored several books. He wrote a phenomenal book on value investing titled Value Investing: From Graham to Buffett and Beyond , and has written several other books on topics including globalization,marketing and media companies.
I recently attended the Columbia Investment Management Conference. Bruce Greenwald was the moderator of the morning panel. He was extremely busy and swamped by dozens of people who wanted to speak to him, but He was kind enough to answer a few of my questions. I would also like to thank Keisha Marks who helped arrange the conference and this interview in particular.
Below is our conversation:
Jacob Wolinsky: You mentioned this in the panel and I saw a CNBC interview with you where you mentioned this also. You discussed why so many value investors got burned during the financial crisis. You stated that many value investors focused too much on earnings power and not on the balance sheet, this was especially true in regards to financial stocks. I am curious if you believe these value investors learned their lesson, and will place a higher emphasis on a strong balance sheet in the future?
Bruce Greenwald: People are what they are, and if you listen to what value investors are saying it does not seem that they are changing their approaches.
I am no different. I have a separate career as a macro economist and forecast. In particular in July of 2008 I said the economy is going to be a disaster, this would be ugly and the auto companies would go bankrupt. In 2007 I made a forecast that there were huge structural problems with huge potential risks, but that you could buy instruments such as derivatives (i.e. CDSs) to measure against these risks for low prices.
Having said all that I would go back and ignore it. Value investing was about micro. You look at a company’s balance sheets and income statements. I would like to think, in light of this experience, that I now supplement the micro analysis with a careful macro analysis but I don’t do this and I don’t think I should.
So no, I do not think people change that much. Income investors will be income investors and asset investors will asset investors and I do not think we will see much change in that.
One of the things the value investors did well is that they did not bail out at the bottom.
Jacob Wolinsky: On a similar note I interviewed Whitney Tilson yesterday and one lesson he took out of the crisis is that he will take more of a top down approach to investing (not a complete top down approach). He said instead of being 98% bottom up and 2 % top down he will in the future be more likely to be 75% bottom up and 25% top down. He stated that he was so obsessed with housing that it caused him to hedge his bets by shorting some financial stocks. (This obviously would be anathema to Warren Buffett, Benjamin Graham or Peter Lynch. Who take entirely bottom up approaches). Do you think value investors in the future will take more of a top down approach?
Bruce Greenwald: In general, no. And when they do they are prey to the psychological biases that we are all prey to. When Charlie Munger says America is in serious trouble, he still continues to invest in American companies at the right price. Maybe America is in serious trouble but this is likely to be true with only a 60% probability but to not a 100% probability. “If you over weighed the forecast of macro trouble, you might have bailed out at the bottom of the market
Jacob Wolinsky: Do you see more deleveraging coming?
When you talk about leverage you have to be careful to distinguish between non financial corporate debt, financial corporate debt, household debt, and Government debt.
The most important is non financial corporate debt. If non-financial companies get in trouble they stop investing, they go bankrupt and lay everyone off. Thus high levels of non-financial corporate debt are very damaging. But non-financial companies have been reducing debt for many years. With the consumers when you talk about aggregate debt you have to talk about how mal-distributed the assets and debt are. All the assets are in the top 20% of households and much of the debt is in the bottom 80% of households. The lower income households were probably spending 110% of their income in periods like 2005-2006 when the national savings rate was zero. The savings rate is now is about 3.5% and much of that is rich households increasing their savings rate. So we are not out of the woods on that one.
The financial system continues to be a big problem and is still way over-leveraged. But with extensive commercial real estate loan losses not yet recognized, financial institutions may have a tough time paying down debt.
Jacob Wolinsky: The investment banks or the commercial banks also?
Bruce Greenwald: All of them. The big uncertainty is that commercial properties are selling for 50% of what they sold for in 2006 and 2007. They were levered up 85% so now you have 50% value against the 85% of what the banks own in their commercial real estate portfolio. That means in their commercial real estate portfolio they have write downs of 40%, you take those off their balance sheets and they don’t look so hot.
But despite all the talk about the banks not lending, the non financial companies are fine and not interested in borrowing much. I think we are going to fix they banks and it won’t make a big difference in the economy.
Then we have the government where all the debt is going now and that has long term consequences. They have to pay for it with taxes or cuts in entitlements. The implied debt with Medicare and other entitlements is enormous, 50 or 60 trillion, and adding 10 trillion makes the problem worst.
Jacob Wolinsky: You have criticized the Burlington Northern Santa Fe (NYSE:BNI) acquisition by Berkshire Hathaway (BRK-A). Many other investors have agreed with your analysis and think Warren Buffett overpaid. Do you still hold the same views?
The worst part is that there is no obvious upside to make the transaction a successful one. You can look at the increase in margins between 2002-2009 which Buffett likes to see. On this basis you might say that they are operating better than their competitors with prospects of increasing future profits.
But there are two numbers it is useful to know. A ton mile by rail takes 1/420th of a gallon of diesel; a ton mile by truck takes about 1/180th of a gallon. If you take the rise in the price of diesel between 2002-2009 and apply that differential it accounts for all this pricing gain BNI has seen over that period.
Worse most of it should have come to the bottom line. But less than half of it came down to the bottom line so they are not managing costs really well. Also BNI reports replacement capital expense higher then depreciation. So the actual profits are less than the reported profits he paid a twenty times multiple for.
So except for an increase in the price of oil, there is no obvious upside. Buffett has always talked about being patient. Since you get possibly twenty good opportunities in a life time you have to wait for them. This is not one of those opportunities, and he even admits that. Alternatively he might have bought American Express (NYSE:AXP) at the bottom of the market, which probably was one of those once in a lifetime opportunity.