SPEAKER: So Mr. O'Glove
is a Wall Street veteran known for pioneering red
flag deviation analyses, and he's the author of
"Quality of Earnings-- The Investor's Guide to Figure
Out How Much Money a Company Is Really Making." His work is amongst
the must-reads by industry icons including
Tom Gardner of the Motley Fool and on Cuppy's book list as one
of the top financial accounting books of all time. I could go on and
on about the book, but this talk is about him. Over to you, sir. Thank you so much. THORNTON L. O'GLOVE:
Boy, [? Surum, ?] I really thank you
for your patience. So much time putting
this together. All of you taking time out
from lunch to come here. My family, and when I look at
some of the personages that have been here-- Barack Obama,
Hillary Clinton, Nassim Taleb, "The Black Swan,"
it goes on and on. I sort of feel like a
pygmy in their company. And as I tell you later when
I get to Berkshire Hathaway, if Houdini can come
back to life and wave a magic wand as a
financial magician, it would be great for Warren
Buffett to come out here and for me to debate
Warren Buffet on what he's not going to do. We're talking about
disassembling all the company. All 90 operating companies
will be spun off tax-free to shareholders. The $360 billion market
cap here, again, it's like waving a magic wand. It'll go up to a
trillion dollars, but I'll go more into this
and the mind of Warren Buffett and why he chooses this path
of acquiring and continuing to conglomerate, rather
than deconglomerate. And a little bit more
about my background, I was born and raised
in San Francisco, got a BA from San
Francisco State, an MBA from the University of
California-Berkeley. I was a stockbroker
for a number of years. When I was a stockbroker, I
used to read these prospectuses. My specialty was selling
new offerings by prospectus, and the prospectus had about
120 pages of dense content. I was the only one in
the office that bothered to read the prospectus. So that gave me the idea to
become a security analyst, and I left the
brokerage business to go two years University
of California-Berkeley, and that really helped me
get more of a base and so on. And then I went
on to Wall Street. I worked for a
couple of firms and I got the idea--
I'll tell you where I got the idea of this
"Quality of Earnings" report. This book really changed
my life in the future. The "Quality of Earnings" report
was an institutional report for professional investors,
banks, mutual funds, investment advisers. Now we'll go on to what
this presentation is about. Part one, financial
deviation analysis, the "Quality of Earnings" book. What I like about the book is
knowing financial analysis, but it can help your mind
look for financial deviations and other deviations. One of my hobbies is I
can't pick up a paper without seeing either a
positive or negative deviation from the norm. In part two, investing
50 years in the market, I wish I could have
some of the years back what I know now about the
stock market with hindsight. And this is why when I see
my eye doctor, he says, you have perfect
20-20 rear vision, but not so much foresight. And talk about the best pathway,
and I kind of prove this out. It's very simple. You know, I know all
these investors come here, mutual funds, Howard
Marks was here. They all have their own ideas
how to invest and so on. And then part three
is the bonanza. Only after Warren Buffett
leaves the scene will the corporation
change dramatically. Even though he's got it all
figured out in his mind, he doesn't want it changing. But I'll explain why
this is going to happen. So going on to part one
now, I came across a book all the way back in the 1950s,
"How to Lie With Statistics." Everyone should read this. It was written by Darrell Huff. It's sold over two million
copies since the mid-'50s. It's still in print. And here's what he says. Basically, you can
take this to the bank. "Rarely you live through a
day without having statistics forced on you by radio,
television, billboard, or newspaper. This book will keep
you from being fooled. Read it and discover which
statistic is the phony." And by the way, you almost
cannot pick up a newspaper, and you will not see some
example of rigged statistics. It may involve
school grades, maybe even involve how many ships
are in the US military, how many Special Forces
are really in Iraq, because they don't
count the number who are going to go on rotation,
so they leave out 1,000. That's another way of
rigging statistics. And I love this
quote by Disraeli, the Victorian prime
minister of England. He said, "There are three kinds
of lies-- lies, damn lies, and statistics." And then the famous H.G. Wells
said, "Statistical thinking one day will be as necessary
for efficient citizenship as the ability to
read and write." Well, that's never
happened, never will happen. Always remember, whenever you
look at statistics, a contract, whatever's handed you in
the form of statistics, the presenter has
the upper hand. Everyone has a bias. So the Department of Labor
has a bias in keeping down the inflation rate. The inflation rate,
they claim, is 2%. It's nowhere near 2%. I wish Janet Yellen
could come here for 30 seconds, the head of
the Federal Reserve, and I say, I don't think you eat food. I don't think you pay rent. You don't have any
medical expense. You don't have any
tuition expense, because you say the
tuition's only 2%. The real rate of inflation
runs 5% or 6% right now. That's the real rate. The deficit, you'll read
a $500 billion deficit. The deficit's not $500 billion. The current deficit in the
last 12 months is $1 trillion. It's very simple to know
what the deficit is. It's the increase in government
debt over a period of time. But the way the government
keeps the statistics, their definition
of today's deficit is one half of the true deficit. Just to give you a few
more examples of this, now Nate Silver has
come here to talk. This is a book that
I think everyone should read, from the president
of the United States on down. People in command,
the head of the FBI, you name it, the higher up
you are in a corporation or whatever you're doing,
you should read this book, because so many
signals are missed. And Nate Silver
is a genius, first of all as an amateur pollster. In 2012 he's the only
one that predicted every state that would
vote for Obama and Romney. The only one. He was an amateur. I'm just going to read
this part here briefly. You see on the board. "'The Signal and the Noise,'
he examines the world of prediction." By the way, talking about
the world of prediction, if you heard Nassim Taleb come
here, he mocks predictors. He says they're all
wearing empty suits. They don't tell you what
their real track record is. And also Warren Buffett,
he makes few predictions but the few he make come true. But at the annual meeting, he'll
say everyone loves predictions. They like to make predictions. And the kings of old
hired soothsayers to tell their fortune. Now he says, "Many predictions
fail, often at great cost to society, because we
have a poor understanding of probability and uncertainty." That's also what
Nassim Taleb goes into. "We are wired to
detect a signal and we mistake more
confident predictions for more accurate ones." The noise-- there's never
been more noise ever in trying to make predictions,
and the reason there are so many mixed signals--
you see, the internet is great. The internet-- however, the
negative on the internet is there's way too much noise. And I was just reading
the "New York Post." I can't believe the statistic. They said the average
worker in tech and so on spends six hours
a day retrieving emails. And my son here-- who's
assistant DA at the district attorney's office, he's head
of the criminal division-- my guess is he spends
three hours a day just on collecting emails. So what happens is you
get all these emails, all this overloading information. You're searching for all
this different information. There's so much texting. This is why somebody who can
train themselves a la Nate Silver to look for the signals
that count will be ahead of their competitors. Now what are three
great missed signals among the many recently? Bernard Madoff, the
greatest Ponzi scheme ever. He claimed he was managing
billions of dollars, and he'd give you a
10% steady return, and people would
beg him to invest. And he said, I have a-- They
would say, what is your method? He would say, I have
a proprietary method. If you already had
money with him, he said, I'll send
you a check tomorrow if you don't want me
to manage your money. And if you don't like
the way I can't tell you exactly how I manage all
these billions of dollars to give you a 10% return
no matter what the bond market does, no matter what
the stock market's doing, you're getting a 10%. And that's how he got so
many, you might say suckers, to invest with him. But nobody, including the
SEC, and the missed signal was, who were his accountants? You've got to realize Bernard
Madoff was very well known on Wall Street. He was president of the
National Association of Security Dealers. He was under
oversight of the SEC. They would come in,
inspect his office. Some investors invested over
a billion dollars with him, but none of them
interviewed his accountant. And who were the accountants? Nobody in the world
ever heard of these two accountants up in a
strip mall, upstate New York. Nobody ever heard of them. If they investigate
the accountants, then what they would
have done is how on earth can this man of his stature
and managing so much money have accountants
nobody ever heard of? You'd almost have to have one
of the big four accountants that handle most of
the corporation audits. So this-- that was
the real signal where he could have been
apprehended years before. Now we come to Enron Corp.
This is one of the biggest accounting scandals ever. You remember Enron Corp? The lights went
out in California and they were gaming the system. Enron, if you wanted to
invest in an energy company, that was the way of going. The company's stock skyrocket. The last year they reported
earnings, they only earned $1. They were selling at
100 times earnings, which is a very high multiple. There were so many red flags. Looking through the
annual report alone, there were dozens of red flags. And one red flag was
off-balance-sheet entities. These are entities that are
not part of the annual report that you can look
at, and all the SEC had to do when they used to
look at their financials, just ask for a separate
income statement balance sheet of these
entities, and they would have saw they
were hiding the losses. They had three sets of books--
one for the shareholder, the other for the IRS,
and the third set of books was these off-balance-sheet
entities that became more and more
notorious, and that's where the real losses. The losses in these
offshore-balance-sheet entities hid the fraudulent gains. Another one, interesting. Derivatives. Nobody listened
to Warren Buffett. This is a case of
Warren Buffett making one of his famous predictions. In 2003, in the annual
report, he said, derivatives will become
weapons of mass destruction, financial mass destruction. I heard him on the
Charlie Rose program. Charlie Rose said, well,
how do you know so sure? Remember this is four years
before the derivatives busted corporate America-- I mean
busted the banks and so on. And they all had to be
saved by the government. He said, I bought general
reinsurance not too long ago. They were loaded with
toxic derivatives. It took me a couple years to
get rid of the derivatives. He writes the most famous
shareholder letter. It's about 20 pages. There's never ever been a
shareholder's letter written before and never will
be one afterwards. It's so informative. It goes into a lot more than
just Berkshire Hathaway. In this case he's talking
about derivatives. Well, who wasn't listening? Alan Greenspan, the
Federal Reserve. Rubin, secretary of state. Bill Clinton, if
you Google him up you'll see where he says
he made a mistake by not having derivatives regulated. However, he didn't know
anything about them. In the case of Rubin,
after destruction with the derivatives he
said it took him eight hours to talk to accountants
to even begin to unwind. They purposely were obtuse
and hard to explain. So that's another thing in life. They give you a
contract or whatever they give you, and
hand in front of you, or a new way of
computing, and this is supposed to really help you. The more dense and obtuse
it is, just be on guard. Now we're on to the
"Quality of Earnings" book, came out all
the way back in 1987. And if I hadn't read about
the "Lying With Statistics," because that's what
accounting's all about-- lying with accounting legally. Once in a while my partner Bob
[? Osteen ?] and I used to say, you know, there isn't
that much fraud. They start with marijuana and
then they'll go on to heroin. When they go on to
heroin, accounting-wise, that's when everything breaks
up, like Enron, WorldCom, you know, these big
accounting scandals. But what you can do with the
generally-accepted accounting-- and don't forget you
pay the accountant. The accountant is paid by you. He will work as close
as he can to you. You may know him socially. In the case of Enron's
auditor, this big auditor, Arthur Andersen, one of
the most famous auditors, was a runaway audit. They went far beyond the
bounds they should have. They should have given
Enron a classified opinion, a qualified opinion. It was so bad, and
Arthur Andersen had been warned a few
years about another audits, so the government went
after them in civil. They actually closed them down. The company had 50,000,
60,000 employees. They-- and what's
interesting is you would have made a lot of
money on Arthur Anderson through a center, because they
had what they call a advice. They give advice
to corporations, and the center went public,
and stock's up about 12 to 1 since it went public. That was a great
buy, because all you were buying-- you weren't
buying accounting now, you're just buying advice
like McKinsley gives. Here we go again on the
points of the analysts. The analysts are trapped. They've got to be bullish. If they're negative,
they may lose their job. The corporation may shut
them out of seminars. Most of them are involved
with underwriting. That's why they-- the company
will call up the research firm and they'll say, no
more underwriting, so if you don't either
get rid of the analysts or silence them. Trump personally fired
an analyst years ago. Don Trump, the Taj Mahal
Casino, they issued bonds that were very risky. And this analyst-- I
still remember his name. No, I remember where he
was from-- Roth Securities in Philadelphia,
entertainment firm. And he said, the bonds
are fraught with risk. Within one week he was gone. Trump called his-- the
head of the firm and said, I'm liable to sue you. By the way, he has been
involved in 2,000 suits, one way or the other. He holds the world
record with suits. Either he's been sued
or he's suing you. And he threatened, of
course, to sue the firm, and the firm had a weak backbone
and they fired the analyst. The auditor's reports
may not be reliable, as the financial
operations are very complex and there's a lot of leeway. You've got thousands
of pages of regulation. You've got the SEC-- remember
the more thousands of pages there are, and also dictum, the
more you can game the system. So the bottom line
is a corporation can tell the
accountant to either be aggressive, not fraudulent,
middle of the road, or conservative. Somewhat similar is
the IRS tax code. It only has 85,000
pages now since 1913. It came from a couple pages,
now it's 85,000 pages. So you read about
these corporations, and they're dodging tax,
they're doing this or that. Well, you can't blame them. They've got 85,000
pages to work with. A lot of it's a gray area. And here again, they're
paying the accountant to eliminate as many
taxes as they can. The chief executive's annual
letters, very interesting. If you own a stock and you read
the annual report each year, the president's letter
might constantly make predictions that go astray. So there is a stock you
wouldn't want to own. Or they'll be very
bullish as usual, but in the back of
the annual report, you look at the
financials and so on and you'll see the company,
the quality of earnings is deteriorating. The future doesn't look good,
using the own financials in the back. In other words, a positive
picture in the front, weak financials in the back. You have income that may be
recurring or non-recurring, one time. The emphasis is to
emphasize income. If you need to
pad your earnings, emphasize the
non-recurring income. The recurring income
comes automatically. And by the way, Trump-- there
was an article on Trump years ago on one of his companies,
where he was flagged down by the SEC for overemphasizing
non-recurring event in his presentation,
a presentation of preliminary earnings. Now here's a good one. They have-- don't forget, the
corporation has the shareholder books, they have the tax books. The tax books are a
lot more conservative. They're conservative. They take higher
depreciation expense than they do for
shareholder expense. They may be writing off expenses
immediately for shareholder reporting-- no,
for tax reporting, but not for
shareholder reporting. The bigger the gap between
the shareholder earnings and the tax earnings, the
lower the quality of earnings. This footnote is
deliberately obtuse. It's hard to read. You may need an accountant
to explain it to you. And this is self-evident. The higher the accounts
receivable-- one red flag that comes up very quick, when the
receivables or inventories really start advancing
quickly in relation to sales, that's almost a dead giveaway
that company sales are going to slow down ahead of time. They may change the way
they report earnings. They may start accelerating
revenue faster than they were. They may start capitalizing
expenses like software. Enron, the last year they were
in business is interesting. They earned $1, up from $0.90. The whole dime
increase in earnings came from capitalized
software, the first time they were capitalizing software. A large corporation like
that's not able to do it, but you seldom do it. But they needed that
dime desperately, so the whole
increase in earnings came from capitalized software,
which the investors, of course, ignored. Now the big bath-- this
can be very bullish, and Hewlett Packard
is a poster child. Hewlett Packard,
by the way, never stops laying off employees. Carly Fiorina came-- Carly
Fiorina laid off thousands-- tens of thousands of employees. Whitman took over, laying
off thousands of employees. I pity the people working
for Hewlett Packard. What they do is they'll
take a big bath. They'll write off inventory,
accounts receivable, reserves. In the case of the
$9 billion company they got stuck with, that
they bought in England-- and it's interesting. They bought a $9
billion company, and their own accountants
look at the books-- this shows you how difficult
it is to see accounting fraud-- and they also hired English
forensic accountants to go over the books. They bought the company. Shortly later a
whistleblower comes, not from the accountants,
a whistleblower tells Hewlett Packard,
you made a bad decision. You bought a company that's
partially engaging in fraud. So now Hewlett Packard
goes to the head of the company, the founder of
the company, starts laughing at him. He says, wait a minute. You sent your accountants
in, the forensic accountants came in, we have our
own big accountants. I claim we're using
generally-accepted accounting. One year later Hewlett
Packard writes off every dime of that $9 billion. And when they write
off the $9 billion, they wrote off as much of
everything else as they can. This is very bullish,
because now you're going to have less
expenses going forward. Your earnings are
going to look better. Here is Amazon's review. Amazon still reviews this
book, and I like this footnote here about, "The most valuable
lesson I learned from the book is to analyze the differences
in income reporting to the IRS versus to the shareholders. Companies keep two types of
books-- one for the IRS, one for the shareholders." There also can be a
third set of books, what I call the rigged books. When a corporation
engages in fraud, you've got shareholder books,
and you have the IRS books, but then you have a third set of
books that they keep internally where they see the difference
between the regular earnings and what the earnings should be. Of course that's not public. That's not shown to the SEC. Now you have a picture of
Houdini, the famous magician, and here's what you
can do with earnings. Remember Cisco Systems,
the great company-- it's still a great company--
went public in the 1990s? It split nine times in a row. It might be a record
for a technology company to split nine times
a row in 10 years. What are the odds
that I, the company, will report for nine years,
36 consecutive quarters, I'm going to report one penny
above Wall Street consensus? The odds are a million to one. But they did this
for nine years. Every quarter was
$0.01 above consensus. During the dot com boom the
company got up to about 80. It was selling about
100 times earnings. I'm going to talk about the
price-earning ratio later. The price-earning
ratio collapsed, like most of the others
during the dot com boom. By the way, most
of those companies didn't even have
earnings anyway. And Cisco no longer needed to
show $0.01 above consensus. It was now down to
12 times earnings, and after going
down to 10 or 12, for years remained
down at 10 or 12. They still had decent earnings,
but the price-earning ratio boom was over. Materiality. I would include my book on
when a company will tell you we have an item
that's immaterial. When they say something
is immaterial, the odds are it's material. But they don't want to clutter
up the balance sheet or income statement with materiality. The doctrine of materiality
is about 5% of the base. If something is 5%
of the base or lower, you don't necessarily have
to disclose an item that's poor quality of earnings. However, let's say that item is
100% of the gain year to year. That's incremental. But the accountants
and management do not look at it incrementally. So there's where the
magic Houdini comes in. Now I'm going to go to the best
pathway for individual success. I know Howard Marks was
here a couple of months ago. They all-- everybody has
their own formula for, quote, "beating the market." I can tell you one thing. Anybody who thinks
the market's efficient should see a psychologist. They really should. The market cannot be efficient,
because what is the formula for the market? Corporate earnings times
the price-earning ratio. What will a dollar of
earnings bring you? You sell for eight
times earnings. Sell for 80 times earnings. The price-earning ratios are
very volatile, up and down. Also it's influenced
by inflation. If it's lower, you'll get a
higher price-earning ratio. If it's higher, you get a
lower price-earning ratio, What is some more about
this long-term investing? Ideally you should
buy as many stocks as you can as young as you can. Buy as many stocks as you can. Even if you only buy a couple
hundred stocks, by the time you retire you
should try to have 50 or 100 individual stocks. Almost never sell. Concentrate on branded
names if you can. Warren Buffett, if you
get to $120 billion stock portfolio in Berkshire
Hathaway, $120 billion, this is individual stocks--
American Express, Washington Post, Bank of America,
Goldman Sachs, so it goes. General Electric. He buys branded names. He's got $120 billion portfolio. He's got 90 operating companies. Many of the operating
companies are all branded names--
Geico Insurance, See's Candy, Kraft,
Heinz, Horton Foods, Burger King,
Berkshire real estate. It goes on and on. Branded names. And the best way to find
branded names at the inception is reading a prospectus. If the market goes down or
you have a very poor market, that's the best time
to buy new offerings. Costco, Microsoft, Nike, Home
Depot, Starbucks, they all started as new offerings. Starbucks-- and by the way,
you don't know how much they're going to go up. Starbucks, I believe,
is up 13,000 to one since it went public in 2000. No, in 1993 it went public. I think it's up 13,000 to one. Microsoft at the height
was up 800 to one. Many of these stocks
are up 1,000 to one. It's incredible. You want to read a
good book on branding, it's called "Branding Relevance"
by Professor David Aaker. He's a professor at the
University of California. He's also in the Hall
of Fame in marketing. In his book he talks
about branded companies and branded products. He doesn't really
discuss the stock market. But what I told him-- I
talked to him briefly. I said, you should take this
book, and all these companies you name, you should research
when they first went public and what the price is
now, and this would be a best-selling investment book. Also it's a great
book to read if you're going-- if you work
for a branded company, obviously you have an edge. A branded company has a
better chance of staying ahead of the competition. He tells those who work
for branded companies how best to stay ahead
of the competition. Some people go into
business for themselves. Try-- easier said than done. Try to acquire for
yourself a branded name. You understand about
the price-earning ratio and how it can go
up and down, so let me just tell you a little
bit about the stock market. Now what is--
investors, you've got to be careful with the
price-earning ratio, because investors
like Howard Marks, they're not buying this
last 12 months' earnings and they're not buying
this year's earnings. They're buying
tomorrow's earnings. Right or wrong, they're all
buying tomorrow's earnings. The market is a
discounting process. How does it do so well
predicting only with hindsight? The depression, when the stock
market went from 380 to 40, 380 to 40. The low in the
depression was 1932. Industrial production
reached the low. The market never went
any lower after '32. In fact, the market
had the biggest rally in its history, percentage-wise,
went from 40 to 200 before the next recession came. 1942, June '42, the
war had just begun. The Battle of Midway. The United States won
a tremendous victory in the Battle of Midway. They sunk four of the Japanese
top eight aircraft carriers. Naval-wise, the Japanese
never recovered. The war went on for
three more years, yet the American market
never went any lower. World War II, the
evacuation from Dunkirk. They evacuated 300,000
troops that were trapped in Dunkirk, France. That helped save England. The war had just started. The market never went any lower. In fact, these
markets kept going up while the war was being fought. What about the
history in America? And you can see why it's so
hard to predict the market. When Eisenhower was
president in the '50s, the market was 10
times earnings. When he left, it was
20 times earnings. And corporate-- also
corporate earnings. The market is a function
of corporate earnings. What are corporate
earnings going to be? Corporate earnings doubled
during his eight years, so now you had a
triple in the market. When Clinton was president,
you had a new post-war high in the Dow. I'm using the Dow because
it's the best, I think, best indicator. You went from 15 times earnings
to about 23 times earnings under Clinton for a time. So not only had the corporate
earnings had been going way up, but look what the
price-earning ratio did. By going from 15 to
22 times earnings, you got a 50% increase
in price right there. What about Jimmy Carter? The opposite happened. You had an almost
runaway inflation. The Dow Jones went down
to six times earnings. The stocks busted because
the price-earning ratios went way down. The book value was only
one times earnings. [? Bowker ?] came along. He saved the economy from what
would have been hyperinflation, and the market
recovered enormously. Now when Howard Marks was here,
he talked about the nifty 50. What happens with the
market, and the reason it's so hard to predict,
is you get these bubbles, or you get these fads. So in the '70s, almost
every serious investor bought the nifty 50. The nifty 50 were
blue chip stocks-- Merck, Procter and Gamble. The problem was they were
selling at 50 times earnings. That bubble burst. The earnings did not go down. The stocks remained
viable, but look what happened to these people. They bought at 40 and
50 times earnings, it went down 15 times
earnings and stayed down there for many years. Some of them to this
day, good companies, have not gone above
15 times earnings. Now how can I prove out
very simply my thesis, the more stocks you buy? My wife, sitting here,
belongs to an investment club. They own 35 stocks, and
over a period of years, they have outperformed
the market. They've tripled. The value of the investment
portfolio has tripled. I run into people and they say,
could you look at my portfolio? And I say, I don't
want to-- I don't need to look at your portfolio,
and don't tell me how many dollars in the portfolio. All I want to know is
how many stocks you own. Just give me the names. I've never failed to run
into an individual that has a large amount
of stocks that hasn't outperformed the market. My next door neighbor,
he's got 40 stocks. He's 88 now. He's never sold
any of his stocks. I recognize all the names. I have another neighbor,
he's an energy consultant. He has 100 stocks. Well, he's in pretty good shape. And he's never sold a stock. And then we have a woman
acquaintance of ours. A couple years ago, I asked
her how many stocks she owns. 300! Owns 300 stocks. And then a couple
years later, I saw her. I said, do you still own 300? She said no, I own 200. I got in the hands of
an investment adviser-- which is the worst thing she
could ever do, and by the way, you cannot do this. If you have an investment
adviser or stockbroker, they're going to turn you
over, the number of stocks. You're going to have a turnover. And when you look at mutual
funds, the higher the turnover, they'll have less success
than some other mutual fund only turning over 20%. And I said, are
you sorry now you sold any of these 100 stocks? And she said yes. And the other thing I asked
these individuals, when they do sell stocks-- and
by the way, look. I'm not saying you
shouldn't sell any stocks. If the handwriting is on the
wall, by the time you know it, the stock will
already be down 50%. I guarantee you that. But in some ways it's
better to sell the stock 50% down before it goes to
oblivion, like Polaroid. And Avon is way down, and
Eastman Kodak long ago is no longer a blue chip. If I was younger, I'd
have a booking agent and I'd go on tour to lecture
about Warren Buffett, the mind and the company. I think I know his mind,
company, as well as anybody. He has the most
multi-dimensional mind of any chief executive officer
in the history of America. He's the greatest acquirer of
corporate corporations ever. If you invested with him
in '65 when he started, $10,000 became $15 million. He's also a world-class
investor in individual stocks. Like I said, they've got a
portfolio of $120 billion. He's an organizational
genius, 340,000 employees. He's got 26 preside
over the company. 26 at headquarters. General Electric, a much smaller
conglomerate, has thousands. The market cap is $360 billion. He's got the company
in a lock box because he owns an
incredible 25% voting control as an individual himself. The other inside, he's
got 40% voting control. He owns 20% economic
interest in this company. That's $70 billion. He's only paid one cash
dividend in all these years. He only had one spin-off. Every time at the
annual meeting, they ask him, how about
cash dividends or spin-offs? The two words are always
the same-- absolutely not. But when you read the
shareholder's letter, and fantasy would
be to have him here, debate him for half an hour on
why he should deconglomerate instead of continuing to-- what
he calls a sprawling company. Those are his words. And he says he and his
sidekick, Charlie Munger, are going to continue
to buy companies. Buffett's 85, Munger's 92. That's their hobby
now, buying companies. But if he spun off all
these 90 companies, the stock would
double overnight, and then what would
happen is these spin-offs would have spin-offs
of spin-offs. So you have Kraft, Heinz. There are so many
companies he has where you could have many spin-offs. You'd have over 200
publicly traded companies on a tax-free spin-off basis
all paying cash dividend. What does he say in
the annual report? He contradicts himself. He says, I leave these
managements alone to the point of abdication. That's his word, abdication. But then in the next
sentence he says, I don't trust some of
the excess cash flow. So the tens of billions of
dollars of excess cash flow go up to headquarters
so he can continue to make these acquisitions. But the fact remains every
one of these companies was successful before
he bought them. He's never bought a turnaround. In the annual report he says,
if you have any tips for me to buy a company, I
do not want a company with any problems or
anything like that. We don't have the
staff to handle it. And also he said the
managements are so good, and their successors,
that when I'm gone, even a fool would
be hard-pressed to run it into the ground. And finally, another
case he makes for dissolving this corporation
in favor of the shareholders is Henry Singleton, he says
is the greatest presider over conglomerates I ever met. He was famous for Teledyne. Henry Singleton shrunk
80% of his shares. By the time he was finished
managing the corporation, 80% of the shares were shrunk. He was one of the pioneers
in rebuying shares, and also he said there's
a time to deconglomerate. So when he reached retirement
age-- in his case, in his 70s-- he spun off the important
divisions to shareholders. So Warren Buffett does not
follow what he preaches. So what do we have here? We have an index company
that would-- it's an index. It's the only index fund, like
it has all the [INAUDIBLE] of an index fund, but
has equity kickers. And here's my
prediction, which may be the only one of its kind. Why does Warren Buffett-- why
is he so confident there will be no change after he's gone? Because he's got Bill Gates. The lock box now goes to
Bill Gates Foundation. The foundation already
has $45 billion. Right now, with
this $70 billion, two thirds of what Buffett has,
his net worth is Berkshire, is going to go to the
Bill Gates Foundation. Why would you leave
two thirds to already which is the largest
foundation, private foundation, in the world? The reason is you want
Bill Gates Foundation to have the voting control. Bill Gates, who is
his bridge playing partner, personal friend,
sits on the board, they have agreed
we will continue to do what we're doing
under different managers. That's all. We're not going to get
engaged in spin-offs or being paid cash dividends. I really thank you
for your attendance. Are we about on target now? SPEAKER: Yes. THORNTON L. O'GLOVE:
OK, so any questions you have on any subject
and so on, just feel free. AUDIENCE: Yeah, thank
you so much for the talk. So we've had a couple guests in
the past couple of weeks talk about sort of the value
of long-term investing. Do you think it's
viable at all to think about short-term investing
in the long term? So not exactly day trading,
but things of that nature, where your period of
holding is on average, like, a week or a month. Do you think that's
a viable strategy at all for years to come? THORNTON L. O'GLOVE:
I myself, I've never been able to succeed very
well with short-term investing. There are some that-- a
few individuals that do very well short-term investing. Bogle, the high priest
of the index funds, he swears that over
time you do better as a long-term
investor in index fund. Most mutual firms
investment advisers do not beat the market. And one reason they don't
beat the market is the fees also weigh against you. And you'd be surprised with 2%,
if you own a fund for 20 years, and how much 2% can wind up
decreasing your performance by-- about one third. And there's another
hidden factor out there. There's the spread
in buying stocks. There is a spread
in buying stocks. Sometimes there might
be a dime spread. So there's a cost, the more
you turn over that fund, the higher your costs
are going to be. And I forgot to say something
about long-term investing and owning a lot of stocks. Psychologically, you're going
to be better off the more stocks you own, because when
you have these market crashes-- a market crash is 40% or
50%, and the market crashes I can remember is in the '70s,
'87, early '90s, early 2000, and then we had
another one 2008. Although your stocks will
go down-- I own 100 stocks, you own 10. Well, your 10 stocks are
going to go way down. So are mine. But psychologically,
you're going to feel much better off
with those 100 stocks. You'll be less inclined to sell. You'd be surprised how these
crashes really weigh on people, and the trigger-- all they
need to trigger an investment adviser or their
wife or whatever to say you own too many stocks. Sell them, you
know, what you can. SPEAKER: How a technology
company can capitalize software expense and the earnings
can look really good for a one-time change? THORNTON L. O'GLOVE: Yeah,
here again a great example. First of all, a small company
is more likely to capitalize software for IRS purposes. You don't have to
capitalize software. Software is an
immediate expense. Most large companies
don't capitalize software, but if you really need a
jolt in earnings, you defer, you'll amortize the software. And Enron is a great example,
selling at 100 times earnings. If they didn't capitalize
that dime of software, the entire gain-- you've got
to remember, 100% of the gain came from capitalizing
software, that one item. $0.90 up to $1. Well, the earnings,
the stock, if they earned $0.95 instead
of $1, the stock would have gone down 50 points. SPEAKER: So the way he
defines owner earnings, he says it's net income plus
depreciation plus amortization minus capital expenditures. THORNTON L. O'GLOVE:
You know what that is? Cash flow. What that is, that's the
best definition of cash flow. Warren Buffett makes
fun out of non-GAAP and all these other
numbers they come up with. Here again, lying
with statistic. You'll read in "The
Wall Street Journal" day after day now bigger
and bigger gap between GAAP and adjusted earnings,
which may not include the compensation on workers. They may leave out
what is recurring. I mean, what is recurring,
they'll emphasize. What's non-recurring,
they'll de-emphasize. That won't be part
of adjusted earnings. And Warren Buffett
is real full of this. He says you should-
GAAP is tough enough, and you shouldn't
have these other types of supplementary earnings. I would buy some ETFs, although
they haven't been around long enough. I don't know how they're
going to do in the next crash. Some people are
leery of these ETFs. They become so large you may
not be able get out of them. I'd be so much leerier of
them, maybe have a few ETFs. I'd be very careful,
especially ones with leverage. I stay away with
leverage, and I would just try to buy individual
stocks maybe. Oh, I forgot. Or a masseuse my wife
has a masseuse that has come in for 20 years now. He's got 100 stocks. He reads "Value
Line." "Value Line" is the best
publication to give you a quick overview
of all the stats and what they think
about a stock. It's just one page. It's full of more information
than any other source It'll give you
predictions on earnings, what the cash flow has been. It's remarkable what
"Value Line" does. They've been in
business for 50 years. He looks at "Value Line." He spends a lot of time
looking at "Value Line," or he went in Ross Stores. One mistake I made. I went in Ross Stores
with my wife years ago, and they had-- it's a great
discounter store selling all kinds of merchandise. They have a branded name. They have few competitors. Ross Stores is practically
up 1,000 to one. You wouldn't believe
it over the years. And another thing
that happens when you get hold of one of these
home runs, most of them don't pay dividends
at the start. Starbucks didn't pay a dividend. Microsoft never paid a dividend. But what happened is the
longer you own them-- and the price-earning
ratio will go higher earlier, but as the
price-earning ratio levels off, which it has to do, that's when
they start paying dividends, and the dividends
themselves can be a bonanza. Now, the stock market,
when you look at how much the stock market's
gone up, the Dow Jones, one third is a
function of dividends. One third, function
of dividends. No, I don't think the
stock market is overvalued. Going ahead back to the '50s,
it went from 10 times earnings to 22 times earnings when
Eisenhower left office, and you know what's interesting? This shows you why anybody
pretends to predict the market except on a long-term basis. Incredibly, Eisenhower
left office in '62. Do you know the price-earning
ratio of the Dow steadily went down from
22 times earnings-- not all at once-- to a
low of six times years later when Carter
became president? And then it went back up
and reached a new high during the past 50 years. It hit about 23 times
earnings under Clinton. And earnings are
defined by "Value Line" as operating earnings. Operating earnings, you leave
out non-recurring earnings. They usually leave
out or write off, so they have their own what I
call the best way of analyzing operating earnings. So I'll be talking about
operating earnings now. SPEAKER: How do you know what's
a good brand ahead of time? THORNTON L. O'GLOVE: Yeah. The question is there are so
many offerings that go public. Obviously if you read David
Aaker's book, at least all these companies
are successful. He doesn't name the thousands
that have gone public over the years. Especially during
the dot com boom, there was really-- you want
to talk about psychology, most of these companies
went public and some of them went up from $10 to
hundreds and hundreds. They had no earnings
even to support them. And today there's a lot of
these price-earning ratio-- these new offerings around
have very little in earnings to support them. So that's a great question. One thing I've also looked
at is the competition. The first thing I look
at is competition. How much competition
do they have? The little the
competition they have, the more the branded name,
or what they call the moat, M-O-A-T, the moat around them,
and the more difficult it is to do what they do, then the
better off you're going to be. Some of the great examples
of all time, McDonald's. Never been a franchise. McDonald's only started
with a few franchises. And the same thing
on Burger King, and on Starbucks, Microsoft. But if you read, Microsoft,
when it first went public, it was in the forefront
of the internet. And one of the biggest
mistakes IBM made was they could have bought them. They didn't buy them. And when you read
a prospectus, he was a young guy-- sometimes
you can see genius. When you read about-- one
thing about prospectus, if you want to
read the 80 pages, it will give you
so much information that is not stilted, because
they come under SEC regulation and they can't hide the
warts and things like that. So if they have
heavy competition, or they have a
particular competitor, that has to be revealed
in the prospectus. Also you have to look at
the price-earning ratio. Remember now, in a
bull market, they're going to come out with these new
offerings that inflated values. The best time to buy a new
offering is when the market is either sideways or you
have recovered from a-- you don't have to have
a crash, but a 20-- for example, a 20% decline. A bear market is loosely
declined as 20% down. A crash, 40%. SPEAKER: We thank you
so much, and thank you all for coming here. Thanks. [APPLAUSE]
I liked his book, but man this is some terrible investment advice.