WWII 081: Control Investing Has Changed from 1950's To Today, Socially Responsible Investing, Non-Dividend Stocks
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Main Topic: How Control Investing Has Changed from 1950's To Today
This episode was inspired by a listener named Dan C. and Dan asked a question about a strategy that Buffett followed in his early days running the Buffett Partnerships. Here is Dan’s question:
“Buffett talks about the three sleeves of his early investment approach Generals, special situations and controls. I'm curious about the latter. Do you have any experience yourself with this category? Just a discussion on control investing in general would be fairly interesting.
First, thank you Dan for this great question and for inspiring this episode.
Dan is referring to Buffett’s realy capital allocation strategy (remember that capital allocation falls within the skills of “portfolio management.”
Here is what Buffett write about this capital allocation strategy in his 1961 Buffett Partnerships letter:
Our avenues of investment break down into three categories. tTheses categorgies have different behavior characteristics and the tway our money is divided among them will have an important effect on our results, relative to the Dow in any given year. The actual percentage division among categories is to some degree planned, but to a great extent, accidental, based upon availability factors.
The first section consists of generally undervalued securities (hereinafter called “generals.: where we have nothing to say about corporate policies and no time table as to when the undervaluation may correct itself.
Skipping a bit, he goes on to say “Our second category consists of “work-outs.” These are securities whose financial results depend on corporate action rather than supply and demand factors create by buyers and sellers of securities.
Skipping again, he writes “The final category is “control” situations where we either control the company or take a very large position and attempt to influence policies of the company. Such operations should definitely be measured on the basis of several years not a given year, they may produce nothing as it is usually to our advantage for the stock to be stagnant market-wise for a long period while we are acquiring it. These situations, too, have relatively little in common with the behavior of the Dow. Sometimes, of course, we buy into a general with the thought in mind that it might develop into a control situation. If the price remains low enough for a long period, this might very well happen. If it moves up before we have a substantial percentage of the company’s stock, we sell at higher levels and complete a successful general operation.”
So the definition of control investing to Buffett back in the 1950’s was that he had either obtained complete control of a company buy accumulating a controlling position over time, or became a major shareholder – enough to get seat on the Board or at least have a voice.
Back in the 1950’s, Buffett could spend a few years leisurely accumulating a stock, becoming either a major shareholder with more than thirty five percent of a company’s stock, or enough to be a major shareholder.
One thing that Buffett did that allowed him to control a number of companies was partner with friends as a cohort that together were able to own enough stock that they could give Buffett their proxy and he could then control the Board and the future of the company.
One example of this kind of control investing Buffett was doing is Dempster Mill Manufacturing . You can read about this in the Buffett Partnership letter from 1962 (just google that phrase).
Buffett first got involved in Dempster buy starting his buying program in 1957, and had enough to get onto the Board in 1958. It wasn’t until August 1961 that obtained majority control by owning 70% of the stock of the company with another 10% held by “a few associates.” Clearly, for Buffett to have accumulated such a large position there were no Corporate defenses.
An example of how Buffett would use activist investing to influence a Board is the story of Sanborn Map, which you can read about in the 1960 Buffett Partnership letter (google it). There were only 105,00 shares of this company outstanding and management only owned 46 shares. Buffett bought 15,000 shares from one shareholder who was unhappy with the situation at the company, recruited two shareholders representing another 18,000 shares, and between Buffett, angry shareholders, and some of Buffetts friends, controlled 26,000 shares.
This was enough to control the company and force the Board to take action. This story is fascinating and an excellent read.
If this sounds familiar to listeners it is because this is what has now become known as “Activist Investing”, a category of investing that I do specific segments about that I call “Activist Investor Action Alerts”.
That being said, there have been major changes in corporate law and in corporate defenses that make much of what Buffett did regularly in the 1950’s obsolete today.
In the 1950’s there was no such thing as the corporate raiders that appeared in the 1980’s along with Michael Milken’s debt raising machine, so there was really no need for poison pills, blocking provisions, shareholder’s rights plans, and other defense mechanisms that were created when corporate raiding came into fashion. There were no requirements to file 13Ds to announce positions representing 5% or more of a company’s outstanding common stock.
Overview of the Williams Act of 1968
Hostile corporate takeover attempts typically take place when a potential acquirer makes a tender offer, or direct offer, to the stockholders of the target company. This process happens over the opposition of the target company’s management, and it usually leads to significant tension between the target company’s management and that of the acquirer. In response to such practice, Congress passed the Williams Act to offer full and fair disclosure to shareholders of the potential target companies, and to establish a mechanism that gives additional time for the acquiring company to explain the acquisition’s purpose.
Here are some of the defenses that companies Boards have built into their corporate by-laws or snap into place when a potential acquirer appears:
· Establishing Differental Voting Rights (DVRs) – This allows insiders to control the company while still having common stock outstanding.
· Employee Stock Ownership Plan (ESOP) – this pretty much ensure that a large block of the stock will vote with management
· Poison pills / Shareholder rights plans: allows existing shareholders the right to buy to purchase stock at a price considerably below the market price, diluting shares held by acquirors. This used be called “watering the stock” and was used all the way back in the late 1800’s by Jay Gould and Jim Fisk to ward off Cornelious Vanderbilt in the battle for the Eerie Railroad.
· White Knight – sell out to a friendly investor
· Greenmail – buy the hostile parties block of stock at a premium to market value
The combination of the William’s Act and the creation of these defenses has made it all but impossible to take control of a company without the company noticing until it is too late. Most of the time these days, you will have to pay up a premium to buy control of a company.
Ask JB: Is Socially Responsible Investing worth it?
submitted 23 hours ago by AndrewLeeMiller
JB SAYS: This may not be a popular opinion but I’m all about shining light on the truth about investing. I don’t prioritize investing in companies that help or de-prioritize companies that hurt the environment. I also will not dump a company just because a CEO says something off-color, or buy a company because a CEO says something amazing.
The truth is that companies of any size will be using up resources. Their employees drive to work burning fossil fuel. Their buildings use resources to build, like trees. Even if they are a “environmental conscience” company, they will still be bad for the environment over-all.
My opinion is that this is just another creation by wall-street and other parties to form more funds and ETFs devoted to it. If you want to be socially responsible and it’s important to you, at least do your research and learn the realities. There are no corporations that are replacing the resources that they use.
As a full-time investor, my goal is to get a return better than indexes over a long period of time. That’s it.
ASK JB Say a publicly listed company announces they will *never* pay a dividend again and legally bind themselves to this promise. They fully intend to hoard and invest all cash that would otherwise be paid as dividends, forever. Do shares in this company have any value?Discussion (self.investing)
submitted 1 day ago by moomin100
JB Says: Berkshire Hathaway is an example of a company that has created tremendous shareholder value, not just on paper, but in reality and in a permanent way. Not all non-dividend companies are sure to create value like Berkshire has, but it is possible. Each company is unique and should be viewed and analyzed on its own. If a company can retain all its earnings and re-invest them at high rates of return, they could create significant shareholder value over the years.
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