MONEY stocks

The Fed Chair Says Stocks Look Expensive. Here’s What She Means

According to one respected measure, prices are high and the long-run prospects for returns aren't so hot.

On Wednesday, Federal Reserve chair Janet Yellen sparked some selling in the stock market when she remarked at conference that stock prices look “quite high.”

Yellen didn’t specify exactly how she was measuring stock valuations, but it’s easy enough to guess at what she means. A standard way to judge whether the market looks cheap or frothy is to look at the share price of companies on the blue-chip S&P 500 index, relative to their earnings—the P/E ratio.

To smooth out the effect of booms and busts in corporate profits, many market analysts today like to look at a version of P/E called the cyclically adjusted P/E (or CAPE). It uses the current S&P level compared with the average of the past 10 years of earnings. It’s also sometimes called the Shiller P/E, after Nobel Prize-winning Yale economist Robert Shiller, who popularized this method.

Right now, the Shiller P/E is about 27, up from about 15 in the immediate wake of the financial crisis.

Shiller recently dropped by MONEY’s offices, and he agrees with Yellen: Stocks look kind of pricey now. But, he adds, that doesn’t mean they couldn’t get even more expensive.

And why, you might ask, does the Fed care what investors pay for stocks? More on that here.

MONEY Warren Buffett

Warren Buffett Is Wrong About Whole Foods

Warren Buffett
Daniel Acker—Bloomberg via Getty Images

Buffett’s recent dig at Whole Foods reveals misguided thinking.

[Editor’s note: This post originally appeared at Motley; John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors.]

I think the world of Warren Buffett. That’s why I just travelled halfway across the country to soak up his wisdom at the 50th annual Berkshire Hathaway shareholders’ meeting. But despite his incredible track record, the Oracle of Omaha occasionally makes an investing mistake – and I believe he’s making one now with Whole Foods Market WHOLE FOODS MARKET INC. WFM -10.69% .

Let’s Go To The Videotape

Towards the beginning of the marathon Q&A session, The New York Times‘ Andrew Ross Sorkin asked Buffett if he was concerned that shifting consumer preferences toward healthier diets might endanger the economic moats of Coca-Cola COCA-COLA COMPANY KO -0.22% and Kraft Foods Group KRAFT FOODS GROUP INC. KRFT -0.43% . Here’s how Buffett responded:

I don’t think there will be anything revolutionary. Food and beverage companies will adjust to the expressed preferences of consumers. No company does well ignoring its consumers. I predict that 20 years from now more Coca-Cola cases will be consumed than today. Back in the late 1930s, Fortune magazine ran an article saying the growth of Coca Cola was over. When we bought stock in the 1980s, people were not enthused about [Coca-Cola’s] growth.

I am probably one-quarter Coca-Cola [big laugh from audience]…. If I had been having broccoli and brussel sprouts, I wouldn’t have lived as long. I would have approached every day like going to jail… Charlie [Munger] and I have enjoyed every meal we’ve ever had except when my grandfather made me eat those damn greens.

It’s amazing how durable [consumer brands are]. Berkshire Hathaway was the largest shareholder of General Foods from 1981 to 1984 – that’s 30-plus years ago. It was bought by Philip Morris and spun out as Kraft. Those same brands are popular today. Heinz goes back to 1869. The ketchup came out in the 1870s. Coca-Cola dates to 1886. It’s a pretty good bet that a lot of people will like the same things.

When I compare drinking Coca-Cola to something they would sell me at Whole Foods, I don’t see a lot of smiles on the faces of people at Whole Foods.

Right Answer, Wrong Approach

Buffett’s conclusions about the future of Coca-Cola and Kraft are probably correct. While consumer preferences have been shifting toward healthier fare, sugary and processed foods are still very popular and will likely remain so for the foreseeable future. And even if a wholesale change in consumer behavior does occur, Coca-Cola and Kraft are capable of adapting. Both companies have the scale advantages, distribution platforms, and marketing muscle to ensure their brands remain relevant for decades to come.

For me, the real issue was Buffett’s rationale. I sensed several behavioral biases that could be causing him to make a suboptimal investment decision.

Survivorship Bias

It’s true that Coca-Cola and Kraft successfully fought off challenges in the 1930s and 1980s. But so did Eastman Kodak, General Motors, and Woolworth’s. Competitive conditions are constantly evolving, and a company’s success several decades ago may not be a valid predictor of its ability to fend off competitors today. By focusing only on those companies that survived, Buffett may be overestimating Coca-Cola and Kraft’s odds of continued success.

Liking Bias

Buffett clearly enjoys Coca-Cola, both as a consumer and a shareholder. Furthermore, he is friends with many of the company’s executives, and his son Howard sits on Coca-Cola’s board of directors. These favorable feelings may make it challenging for Buffett to view the company objectively. We saw evidence of this phenomenon in action last year, when Buffett abstained from voting against an executive compensation program that he viewed as excessive.

Projection Bias

But for me, the biggest flaw in Buffett’s thinking concerned the parting shot he took at Whole Foods.

Because Buffett eats like an unsupervised six-year-old, he incorrectly assumes that most consumers share his eating preferences. This fallacy is probably supported by his choice of dining partners, including Munger, who plowed through an entire box of peanut brittle during the shareholder meeting. But I’ve been to the Omaha Whole Foods, and I saw a store full of happy customers buying premium-priced organic produce. Buffett’s bias against healthy eating is likely causing him to underestimate the appeal of Whole Foods’ brand.

So, Should Berkshire Buy Whole Foods?

There are legitimate reasons not to invest in Whole Foods. The grocery business is intensively competitive, with thin margins and no barriers to entry. Buffett knows this firsthand, as his grandfather owned a grocery store in Omaha where Buffett and Munger both worked as young men. Furthermore, Berkshire recently lost $444 million by investing in Tesco, the leading grocer in the U.K.

But Whole Foods is not your typical grocery store. As the largest retailer of natural and organic foods in the U.S., Whole Foods is commonly perceived by consumers as offering healthier and higher-quality fare. Thanks to its strong brand, Whole Foods can charge premium prices for its products, which enables the grocer to post atypically high sales per square foot, gross margins, and return on invested capital.

Whole Foods possesses many of the characteristics that Buffett loves to see when evaluating investments. It has strong and sustainable competitive advantages, a clean balance sheet, a dedicated and shareholder-friendly management team, and attractive growth prospects. With a P/E ratio of 30, shares don’t appear especially cheap at the moment, but this strikes me as a reasonable price for such a high-quality business. If Buffett could look past his hatred of healthy eating, I suspect he might agree.

MONEY stocks

How Microsoft Became a Market Darling, in Two Charts

Microsoft CEO Satya Nadella
Jim Young—Reuters Microsoft CEO Satya Nadella speaks at the Microsoft Ignite conference in Chicago, Illinois, May 4, 2015.

CEO Satya Nadella has turned an aging tech giant into one of the hottest stocks on the market.

On Tuesday, saw its shares skyrocket as rumors spread of a possible Microsoft acquisition. While Bloomberg has said no deal is imminent, a Salesforce sale would make a lot of sense for a company that has staged an improbable comeback through a newfound focus on cloud services. (Our sister publication made just that case a few days ago.)

When Satya Nadella was named Microsoft’s CEO on February 4, 2014, he was taking over an aging tech giant long known for muddled priorities and a fear of any internal innovation that could challenge the dominance of its Windows operating system. Since then, Nadella has given his company a clear objective—even killing off established but musty brands like Internet Explorer. As the Economist noted in April:

Mr. Nadella’s biggest achievement so far is that he has given Microsoft a coherent purpose in life, as it enters its fifth decade. He sums it up in two mottos. One is “mobile first, cloud first”: since these are where the growth is going to come from, all new products need to be developed for them. The other is “platforms and productivity”.

On the cloud side, Microsoft’s business has been flourishing. Profits from the cloud—that is, software and services available via the Internet—more than doubled in the past quarter, and revenue has increased to $6.3 billion.

Investors are liking the new clarity too. Microsoft’s stock price has surged under its new CEO. Since Nadella took the reins, Microsoft shares are up over 30%, 10 points ahead of the S&P. In comparison, Microsoft’s stock dropped nearly 12% during Ballmer’s tenure and underperformed the market.

Here’s Microsoft’s stock performance under Ballmer:

Microsoft’s share price growth compared to the S&P 500 while Steve Ballmer was CEO.

And here’s its performance since Nadella started:

ycharts_chart (1)

This magical-seeming recovery is still a short-run thing—we’re talking a bit more than year. But Wall Street seems to have Nadella’s back for now. Earlier today, the Wall Street Journal‘s “Heard on the Street” column praised the company’s cloud efforts and called its stock one of the cheapest ways to gain exposure to cloud business. Just a few hours later, as though to confirm the endorsement, shares jumped on merger news.

MONEY stocks

What SeaWorld’s Sinking Stock Really Means

George Skene—Orlando Sentinel/MCT/Alamy Live

The company has failed to recognize the concerns of its customers.

Anyone who has followed SeaWorld Entertainment’s SEAWORLD ENTERTAIN COM USD0.01 SEAS 0% spectacularly sinking share price and related business turbulence knows that the company has faced a tsunami of negativity, and its stock price has gotten torpedoed as it’s been slammed in the top and bottom lines. The idea that many consumers are shunning SeaWorld’s shows because of animal welfare concerns signals a change in how businesses will have to view their many stakeholders — even the silent ones.

Until now, situations like SeaWorld’s could certainly tarnish a company’s brand and alienate some customers, but it would usually be a slow degradation among a niche crowd and difficult to notice in the numbers. SeaWorld’s dramatic situation is a great example of legitimate financial risk for those companies that fail to recognize consumers’ evolving concerns.

Stormy times at SeaWorld

The documentary Blackfish stirred up questions about SeaWorld’s treatment of orcas (also known as killer whales), as well as the death of a trainer. For many people, it’s apparently a lot more difficult to enjoy the wonder of these creatures when pondering their quality of life in small, concrete tanks, cut off from others of their kind — some of many criticisms lobbed at the company regarding the treatment of these social animals.

As a result, SeaWorld’s earnings have been subject to hit after hit. In the year ended Dec. 31, 2013, sales rose an anemic 2.6% and per-share earnings fell by 33.7%. In 2014, its sales fell by 5.6%, and per-share earnings slid 3.4% to $0.57 per share as fewer people frequented its parks.

Last quarter, SeaWorld’s situation continued to be dismal. Revenue fell 2.7%, and it reported a wider-than-expected loss. Attendance at all of SeaWorld’s parks (the company also runs other attractions like Busch Gardens and Sesame Place) fell by 2.2%.

SeaWorld has been exhibiting plenty of signs of business turmoil. In January, it ousted its CEO and announced plans to lay off 311 employees.

Marketing partners like Southwest Airlines SOUTHWEST AIRLINES CO. LUV 0.86% have severed their ties to the company, and some entertainers such as Willie Nelson canceled shows at the company’s parks. A few short weeks ago, Mattel MATTEL INC. MAT -1.52% discontinued its SeaWorld Trainer Barbie.

SeaWorld claims that its critics have it wrong. To repair the damage, it’s been incurring additional costs to get the word out and get back in consumers’ good graces. It recently announced that it’s spending $10 million on an ad campaign including TV, print, and digital messages to rebut critics’ claims and set the record straight on its animal treatment.

SeaWorld’s shares are down 32% in the last 12 months, but given the current turmoil, investors might want to think twice before considering the stock as a bottom-fisher’s dream.

Even as the company defends its honor, it has still suffered costly reputational damage and the costs of the cleanup, and it may have to up the ante in terms of spending on increasing numbers of animal-friendly initiatives than it had otherwise planned as part of its business model.

In recent weeks and even days, SeaWorld has taken a beating. For example, Jane Goodall, a respected scientist known for her lifetime of work with primates, told The Huffington Post this week that SeaWorld “should be closed down.”

The Los Angeles Times recently reported that the Division of Occupational Safety and Health at the California Department of Industrial Relations handed out $26,000 worth of citations to SeaWorld San Diego, saying that SeaWorld isn’t training workers properly to work with killer whales, and several lawsuits have been filed against SeaWorld in recent weeks as well.

For SeaWorld’s side of the story, it has been inviting people to “Ask SeaWorld” here. However, it’s clearly got quite a battle to fight.

The changing horizon

I’ve long viewed animal welfare as an issue that was going to increasingly concern consumers — and hurt some companies.

That’s why I have an appreciation for the quality of some of the companies that have been way ahead of the curve in taking the opposite tact, putting compassion for animals at the heart of their businesses to begin with. The fact that other companies are trying to evolve proves out their strategic vision — and an evolving consumer.

Take Chipotle Mexican Grill CHIPOTLE MEXICAN GRILL INC. CMG 0.25% for example, whose recent pork supply woes include the animal welfare component, since it cut off a supplier who wasn’t treating its pigs in a humane manner. The upshot is that Chipotle already had high standards in place for how animals should be treated as part of its Food with Integrity mission.

Whole Foods Market WHOLE FOODS MARKET INC. WFM -10.69% has been well ahead of the curve, too. It has had an animal welfare ratings system in place for years now. Its shoppers can use it to make buying decisions according to how livestock were treated in life.

You might be surprised, but increasing numbers of companies are addressing such issues as consumers and shareholder activists demand more humane treatment for animals, although it often doesn’t make big news. The Humane Society of the United States has been a major proponent of better treatment for farm animals including pigs, and has tracked and engaged with many big-name companies to sign on to improve their practices or those of their suppliers.

In the last couple months several companies have gotten on the list of those making such moves. Hilton Worldwide HILTON WORLDWIDE H COM USD0.01 HLT 0.07% is transitioning to gestation crate-free pork and cage-free eggs, targeting completion of both moves by 2018. Dunkin’ Donuts DUNKIN BRANDS GROUP DNKN -1.44% has vowed that it will only source gestation crate-free pork by 2022, and it’s looking into the feasibility of providing only cage-free eggs.

Empathy as a competitive advantage

Even far beyond SeaWorld, there’s a larger theme in animal welfare and other social and environmental concerns, too. Some practices are all about putting short-term profit motive at front and center, cutting corners and costs, and ignoring a more humane view.

These days, more consumers (and even increasing numbers of investors, as socially responsible investing and impact investing gain in popularity) are gravely disappointed if not disturbed by some of the ill effects of putting short-term, quarter-by-quarter profit over every other business concern.

Companies that treat all their stakeholders well — even those who can’t talk, like animals — are building a competitive advantage as more people say “no more” to managements who have allowed their businesses to devolve because they focused more on numbers than empathy. In many ways, such companies ensure they will travel far more tranquil waters.

Check back at for more of Alyce Lomax’s columns on environmental, social, and governance issues.

MONEY Small Business

New Ways to Invest in Small Businesses

Cafe owners
Getty Images

When nonprofessional investors are able to put money into small businesses, everyone can benefit.

I met with Paul on Tuesday. He is the CFO of a business start-up. He’s not sure if the next phase of his company’s financing is going to go through. Although he believes in the business model and the mission of the company, some days he thinks he won’t have a job in three weeks.

I met with David on Wednesday. While he’s a great saver and earns a decent buck, he isn’t wealthy. He wants to invest in small companies so much that we’ve set up a “fun money” account, which is 10% of his otherwise well-diversified, passively managed portfolio. “Fun money” is specifically set aside so that he can make individual investments he believes in.

Because of the way small business investing is structured in this country, the likelihood of Paul and David connecting has been infinitesimally small.

This drives me mad.

It’s not just these two who are missing out. Because small companies drive job and economic growth, the economy of the country loses when Paul and David don’t connect. And because the current system of funding is biased, some small businesses are a lot less likely to get funding despite their worthy ideas.

Recent developments could change all this.

To raise their initial start up money, small business owners typically first use their savings, and then appeal to their friends and family. Next, they go to banks. If they get big enough and have certain ambitions and contacts, they can get venture capital funding or private equity funding, which is what Paul was waiting on.

These sources of capital are all enhanced if you are affluent and well connected. Do your friends and family have extra money to invest in your business? Do you know anyone you can talk to at a bank? What about impressing people in the venture capital world? A lot of people with good ideas are shut out.

Enter the Internet. Raising money got a lot easier.

The Power of Reward Sites

With reward sites, startups with good ideas raise money in exchange for rewards.

Sesame, which opens doors remotely from smartphones, raised over $1.4 million on The reward here was a chance to order the device.

Then there is Lammily, Barbie’s realistically proportioned cousin, whose designer raised almost $500,000 through The reward for funding Lammily was the chance to pre-order the doll, and sticker packs with stretch marks, cellulite, freckles, and boo-boos.

The reward sites show that companies can raise large amounts of money through small contributions from a large number of people. Research suggests that reduces company funding gender bias by an order of magnitude and reduces geographic bias as well. Reward sites cater to consumers who love new products and want to support new ideas.

You may get first dibs on a cool new doll, but sending money to a reward site isn’t investing.

The Risks of Private Equity

Traditionally, to get private equity funding, you have to sell to accredited investors — the richest 1% of the population, roughly speaking.

Accredited investor regulations were set up in in the wake of the 1929 crash, when a lot of people got ripped off because they invested in dubious enterprises. The idea was that people with a high level of wealth are sophisticated enough to understand investment risk. Unfortunately, this leaves the Davids of the world — investors who are sophisticated but wealthy — shut out of these types of investments.

Private equity placements are not always a great deal. When I’ve looked into them for clients, I’ve concluded they are expensive, risky, and difficult to get out of, even if you die. The middlemen who offer these and the advisers who sell these seem to be the ones most likely to make money. The best deals I’ve looked at weren’t hawked by sales people or investment advisers, but came through clients’ friends and family.

The rise of Internet portals set up to connect small companies with accredited investors has the potential to cut down on intermediary costs. Still, the sector remains small.

In 2012, President Obama signed the JOBS act, which directed the Securities and Exchange Commission to devise rules opening up small business investing to non-accredited investors.

Some organizations didn’t wait for the SEC to issue the rules. Instead, they dusted off exemptions in the securities legislation that most of us have ignored for 80 years.

States Get Into the Act

Some states have picked up on crowdfunding to boost their economies. Terms vary, but generally investors are subject to investment limits and companies are subject to a cap on raising money. Each individual, for example, might be limited to investing $10,000; each company might be limited to raising $1 million. Both investor and company are generally required to reside in the state.

This is music to ears of people who want to invest locally. The first successful offering using this type of exemption was in Georgia in 2013, where Bohemian Guitars raised approximately $130,000 through

Other Exemptions

Village Power is another example of raising money using an exemption. This intermediary helps organizations set up and fund solar power projects. Village Power coaches their community partners to use an exemption in the SEC rules, which allows for up to 35 local, non-accredited investors.

New Rules Open Doors

New rules issued March 25 by the SEC removed a lot of the barriers for companies raising money and for non-accredited investors.

Companies will be able to raise up to $50 million. Non-accredited investors are welcome to invest, sometimes with limits — 10% of their net worth, say, or 10% of their net income.

Although Kickstarter has said that it won’t sell securities, other fundraising portals, such as Indiegogo, are looking into it.

And if all goes well, Paul, David, and I can start looking for the new opportunities in June of 2015.


Bridget Sullivan Mermel helps clients throughout the country with her comprehensive fee-only financial planning firm based in Chicago. She’s the author of the upcoming book More Money, More Meaning. Both a certified public accountant and a certified financial planner, she specializes in helping clients lower their tax burden with tax-smart investing.

MONEY mutual funds

5 Things You Didn’t Know About the World’s Biggest Bond Fund

The Vanguard Group headquarters in Malvern, Pennsylvania
Mike Mergen—Bloomberg via Getty Images The Vanguard Group headquarters in Malvern, Pennsylvania

Vanguard Total Bond Market, which is now bigger than Pimco Total Return, is a fine fund. But it doesn't quite cover all the bonds you need.

With a whopping $117 billion in assets, Vanguard Total Bond Market Index is now the biggest bond fund in the world, overtaking the long-reigning champ Pimco Total Return, according to data reported by the Wall Street Journal. If you add in the assets held by Vanguard’s exchange-traded fund version of Total Bond Market, the fund controls about $144 billion.

While big in dollar terms, this portfolio isn’t so large in scope. Here are some things you may not know about bondland’s new 800 lb. gorilla:

Despite its name, Vanguard Total Bond Market doesn’t come close to giving you exposure to the total bond market.
Sure, this fund does give you decent market exposure, but it limits that to the universe of high-quality bonds. This means the fund can own debt issued by the U.S. government, government agencies, and “investment grade” corporations with pristine credit.

Only around one tenth of 1 percent of the fund’s assets are held in high-yielding “junk” bonds issued by companies that are considered less than “investment grade.” In the bond world, higher quality issuers can get away with paying lower yields. This explains why the average yield for this fund is a modest 2%.

This fund doesn’t even give you adequate exposure to high-quality corporate bonds.
While Vanguard Total Bond Market does own high-quality corporate securities, they represent less than one quarter of the fund’s assets. With more than 75% of its assets in Treasuries and U.S. agency-related debt, this is more of a government bond fund than anything else.

This is why MONEY has recommended supplementing this fund (which is in our MONEY 50 list of recommended mutual and exchange-traded funds) with a corporate-centric portfolio, such as iShares iBoxx Investment Grade Corporate ETF (which is also in the MONEY 50).

This fund gives you extremely little foreign exposure.
Technically, Vanguard Total Bond Market does own a tiny amount of international debt. But the biggest weighting is to Canada, which makes up less than 1.7% of the fund. In fact, bonds based in the U.K, Germany, Mexico, and France each make up less than 1% of the fund’s total assets.

To really gain foreign exposure, you will have to further supplement this fund with an international fixed income fund, such as Vanguard Total International Bond Index fund, which is also in the MONEY 50.

Unlike the past champ, Pimco Total Return, this fund runs on autopilot.
As its name would indicate, Vanguard Total Bond Market Index is an index fund. This means that instead of being controlled by a star manager who picks and chooses which bonds to buy and sell, this fixed-income portfolio passively tracks a fixed-income market benchmark. In this case, that’s the Barclays Capital U.S. Aggregate Float-Adjusted Index.

Vanguard Total Bond became the biggest bond fund sort of by default.
While Total Bond has been consistently gaining investors in recent years, it didn’t win the crown so much as Pimco Total Return lost it. At its peak, Pimco Total Return wasn’t just the biggest bond fund, it was the largest mutual fund in the world. Yet after approaching nearly $300 billion, Pimco Total Return lost more than half its assets as investors fled amid infighting at Pimco which eventually led to the departure of famed fixed income manager Bill Gross. Today, Pimco Total Return is down to around $117 billion.

MONEY Warren Buffett

5 Critical Takeaways From Berkshire Hathaway’s 50th Anniversary Meeting

One of our top analysts shares what he learned at the Berkshire event.

Berkshire Hathaway is the quintessential capitalist story of meritocracy, grit, and hard work. Humans have a certain fundamental attraction to these success stories that happen against any measure of statistical improbability — this notion of exceptionalism. The best of these stories provide a window into ourselves — that which we are, aren’t, or hope to achieve. Berkshire and its leader, Warren Buffett, in many respects, represent all of these things on some magnified scale.

It is in this spirit that — as shareholders, investors, and lifelong students of great businesses — a group of Fools and I gathered to hear Warren Buffett and Charlie Munger hold court at Berkshire’s 50th-anniversary shareholder meeting. Well, us and a sellout crowd of more than 40,000.

In its 50th year, Berkshire is still a success story that defies traditional classification, both for the scale of shareholder wealth accrual and its seemingly impossible string of consecutive wins. From its relatively humble roots as an investment partnership — itself an incredibly difficult business — to its radical several-decade transformation into an investment, insurance, and industrial conglomerate, Berkshire has continuously defied classification. Where many businesses hardly withstand the test of a decade or two, Berkshire has dominated across a decades-long horizon.

Throughout, from the 1965 acquisition of a struggling textile mill some 50 years ago, transformational acquisitions of insurers (National Indemnity, GEICO, and Gen Re, along with the formation of Berkshire Hathaway Re), and subsequent forays into capital-intensive regulated businesses — namely, utilities and railroads — Berkshire has been different. It has remained relentlessly focused on a more ethical breed of capitalism, shareholder wealth accrual, and fair treatment of its employees.

And so, as investors, we study its success, for clues and in awe. What follows are several bits from the Berkshire 2015 — of evergreen wisdom, notable Berkshire developments, and sage investment advice from the meeting.

1. Brazilians, private equity, and cost-cutting.

Across the past two years, the most notable development in all of Berkshire has been the conglomerate’s expanding relationship with the ruthlessly efficient, obsessively cost-cutting Brazilian private-equity shop 3G. Berkshire partnered with 3G on deals to acquire H.J. Heinz and Kraft Foods KRAFT FOODS GROUP INC. KRFT -0.43% . They’re among Berkshire’s largest deals in some time, and the partnership hasn’t been without controversy.

At various points across the day, shareholders questioned 3G’s ethos and philosophy as being at odds with Berkshire’s historically cushier brand of capitalism. 3G plays hardball, or so it seems, but Buffett brushed these criticisms off.

“You will have never found a statement from Charlie or me saying that a business should have more people than needed,” he said. “3G has been buying businesses that have too many people.”

More to the point, he cited consumer-goods firms as still ripe for consolidation. The opportunity, for Berkshire and 3G, is substantial — to streamline other organizations, by feeding fatty, lazy consumer-goods firms’ wares through the combined Heinz-Kraft entity’s formidable supply chain. And for Berkshire shareholders, it might prove to be the elephant gun-sized deal they’ve long awaited.

Consider the potential: Yum! Brands’ YUM BRANDS YUM -0.87% market cap is $40 billion, Mondelez MONDELEZ INTERNATIONAL INC. MDLZ 0.34% sits at $64 billion, Hershey HERSHEY FOODS HSY 0.33% is valued at $21 billion, and Campbell Soup CAMPBELL SOUP CO. CPB -0.42% currently fetches $14 billion. I’d expect deals of this flavor to be of increasing import, and a key source of upside optionality in Berkshire shares for decades to come. Viewed 20 years hence, the 3G partnership could indeed prove to be one of Buffett’s master strokes.

2. Railroads: the new float.

On account of what, in simplest terms, amounts to a tax loophole, reported taxes at Berkshire’s regulated utilities are significantly higher than cash taxes. That loophole creates a source of float — an interest-free loan, if you will, that Berkshire may invest. When analyst Jonathan Brandt asked whether it might prove to be an enduring source of float, Buffett demurred.

I’ll respectfully disagree. To the extent that Buffett and Berkshire continue to invest in the regulated utilities, the float generated by this tax treatment can be sustained and grow. And it could be quite substantial.

In the time since Berkshire’s 2010 acquisition of Burlington Northern Santa Fe, it’s increased more than $10 billion. They currently sit near $35 billion, where float is $80 billion. I don’t think it’s impossible to contemplate that Berkshire’s deferred tax liabilities from the regulated utilities could more than double across the next 10 to 15 years, providing a meaningful and heretofore underappreciated source of investable funds.

So why would Buffett play coy or downplay the potential? Simple. He’s hedging. Acknowledging as much — that he’s exploiting the tax code — risks killing a golden goose. Always fear the taxman.

3. Alternative energy, and profit sources.

Much has been made of the threat from alternative energy to MidAmerican Energy and, specifically, distributed power generation. The concern is that power served off the grid, via solar power, might disintermediate traditional power generation. As solar and distributed power become viable options, regulated utilities have two options — to adapt to changing climes, by implementing distributable power-generation technologies and/or pushing power costs lower, or fight and possibly lose.

For MidAmerican, a cash cow for Berkshire, that could prove to be a risk. But in CEO Greg Abel’s remarks, I found cause for optimism. MidAmerican has for years been actively transitioning its power-generation fleet to solar and wind applications, in an effort to drive costs lower. In his remarks, Abel seemed quite willing to explore any and all economic options.

In an otherwise staid industry, this is not a CEO who fears change. I expect that will accrue to MidAmerican and Berkshire’s advantage.

4. Trademark Mungerisms.

Charlie Munger — Buffett’s partner, with an acerbic and incisive wit, and a lover of knowledge accrual — is well known for his pithy, illuminating one-liners. No recount would be complete without them, and a few hit home.

  • On including certain countries in the euro: “You shouldn’t create a partnership with your drunken, shiftless brother-in-law.”
  • On activist investors: “I’m trying to think of any activists I’d like to marry into the family.”
  • On their success: “If people weren’t so often wrong, we wouldn’t be so rich.”
  • On acquiring knowledge: “It’s dishonorable to stay stupider than you need to be.”

5. Semi-reckless prediction.

On account of the growing importance of the regulated utility businesses, my (perhaps flawed) belief that the float from these businesses will assume increasing importance, and the semi-continuous accolades he’s a recipient of, I’d peg Greg Abel for the CEO spot. Dark-horse candidate: Matt Rose, CEO of BNSF.

And to Munger’s exhortation on getting smarter, I don’t think we left dumber. If there are three rules of engagement my years of Berkshire shareholding have reinforced, they’re simultaneously simple and hard to practice: Be contrarian, disciplined, and curious. In that regard, I guess you might say that I’ve emerged enriched not only financially, but also intrinsically.

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8 Lessons ‘Star Wars’ Taught Us About Money, for May the Fourth

In honor of May the Fourth (a.k.a. Star Wars Day), we are geeking out with a roundup of lessons that the "Star Wars" movies can teach about careers, investing, borrowing, being smart shoppers, and resisting the temptation of the Dark Side.

On Star Wars Day, let us be among the first to say, “May the Fourth be with you.” (Get it?) And let us put our Star Wars and personal finance nerd credentials on display by sharing some money lessons that can be gleaned from all the action and drama that unfolded a long time ago, in a galaxy far, far away.

  • Negotiate for the Best Deal

    Lucasfilm Ltd.—courtesy Everett Collection STAR WARS: EPISODE IV - A NEW HOPE

    In “The Phantom Menace,” Jedi Master Qui-Gon Jinn is stuck on the planet Tatooine with a broken ship, and without the money (or “credits”) to get it repaired. He haggles adeptly with the junk dealer Watto over the terms of a wager that nets both the part necessary to fix the ship, as well as the release of the slave Anakin Skywalker, who grows up to become Darth Vader. Another example of good negotiating comes in “A New Hope,” when Anakin’s son Luke and his Uncle Owen insist on a new droid (R2D2) after one they’d just purchased breaks down.

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  • Pay Off Your Debts

    Lucasfilm Ltd./courtesy Everett Collection STAR WARS: EPISODE IV - A NEW HOPE

    For most of the time moviegoers get to know Han Solo, he is haunted by a debt owed to the underworld boss Jabba the Hutt. Bounty hunters—the equivalent of debt collection agencies in the “Star Wars” universe—are dispatched to track down Solo, and eventually he winds up in the hands of Boba Fett. Solo is frozen in carbonite and carted off to Jabba the Hutt’s palace as a prize wall ornament. (Side note: It’s best to avoid becoming indebted to murderous crime lords in the first place.)

    MORE: Should I Save or Pay Off Debt?

  • Make Your Boss Happy

    LucasFilm/20th Century Fox—The Kobal Collection RETURN OF THE JEDI

    Let’s hope your boss doesn’t react to disappointment like Darth Vader, who uses the Force to remotely choke an admiral to death after Rebel ships elude the Empire. “You have failed me for the last time,” Vader says as the man drops to the ground, and then promptly promotes another staffer into the position of command. (We’ve heard some variation of this scene takes place, with slightly less lethal results, in Wall Street offices on a regular basis.) The moral is: To keep your job—and to breathe easy, so to speak—always be mindful of avoiding missteps that could turn the boss into a vengeful tyrant.

    MORE: Why It Pays to Make Your Boss Your BFF

  • Work for Something Beyond Money & Power


    Most research indicates that once a person earns a decent salary ($75,000 in the U.S.), making more money does not increase happiness. In fact, some high-paying jobs tend to make people miserable. The happiest employees are instead those who are challenged and find their work fulfilling. That doesn’t necessarily mean they’re working for some great humanitarian cause. A 2015 survey named construction workers as the happiest category of employees, and that one’s satisfaction with colleagues and satisfaction with the nature of the work were most important in determining who is happy at work. It’s hard to think that money-driven bounty hunters like Boba Fett and Greedo were happy, nor that people working for the Empire felt good about their jobs. Look at what eventually happens to the power-hungry Emperor too.

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  • The Weak-Minded Are Easily Tricked

    Lucasfilm Ltd.—courtesy Everett Collection STAR WARS: EPISODE IV - A NEW HOPE

    Jedi mind tricks are used to persuade individuals to do what the Jedi wants—to stop a bar fight that’s about to happen, for example, or to overlook one’s duty to find two wanted droids. But these mind tricks only work on the weak-minded. So too do the mind tricks routinely practiced by marketers, advertisers, and sales people, who are in the business of persuading the masses into buying merchandise and adopting habits that typically benefit the seller more than the buyer. Be skeptical rather than weak-minded and easily persuaded. Don’t allow any advertisement, shameless marketing ploy, or car salesman to successfully play some “These aren’t the droids you’re looking for” trick on you.

    MORE: 10 Subliminal Retail Tricks You’re Probably Falling For

  • Penny Pinching Can Lead to Your Doom

    courtesy Everett Collection—Copyright © Everett Collection / Everett Collection STAR WARS: EPISODE IV - A NEW HOPE

    The Empire seemed to spare no expense on the building of the Death Star, the moon-sized battle station powerful enough to destroy planets. Yet some genius overlooked the design flaw that allowed the Rebels to fly inside and blow the thing up. Surely the Empire could have spent a few more bucks—perhaps by scaling back slightly on the power of the super laser—and made the Death Star truly impenetrable. Likewise, if you’re buying a house, it’s unwise to pinch pennies by, say, skipping the home inspection or ignoring landscaping issues that will lead to water in the basement. Spending a bit more upfront on things like better-insulated windows and energy-efficient appliances and heating and cooling systems will save you money in the long run as well. Finally, don’t skimp on repairs and upkeep for big-ticket purchases like your home and car: Addressing minor problems as they arise will help you avoid cost explosions down the line.

    MORE: What Are the Steps in a Home Purchase?
    MORE: Should I Get a Home Inspection?

  • Develop Good Mentor-Mentee Relationships

    Lucas Films/Mary Evans/Ronald Gr—Everett Collection

    The theme of teaching, learning, and mentorship runs throughout “Star Wars,” with Qui-Gon Jinn offering guidance and knowledge to his young Padawan Obi-Wan Kenobi, Obi-Wan serving as mentor to both Anakin and Luke Skywalker, and Yoda passing along nuggets of wisdom for pretty much everybody. On the other hand, Darth Maul, Count Dooku (Darth Tyranus), and Darth Vader, who all head to the Dark Side and choose the evil Sith Lord Darth Sidious (a.k.a. Emperor Palpatine) as their mentor, don’t exactly live happily ever after.

    MORE: How to Convince Someone You’ve Never Met to Be Your Mentor

  • Size Matters Not

    20th Century Fox—Courtesy Everett Collection STAR WARS: EPISODE III-REVENGE OF THE SITH

    Among other things, this bit of wisdom from Yoda applies to one’s career (“small” jobs and “small” companies can represent terrific opportunities) and the amount of money a young worker can allocate to start an investment portfolio. It may seem silly to begin investing when your expenses eat up all but perhaps $1,000 per year. But there are many wise moves to make with a spare $1,000, let alone $10,000, and no matter how much you start with, investing early on is proven to add up big time over the course of several decades. The goal is that some day your portfolio will contain buying power equivalent to Yoda’s grasp of the Force. Hopefully, this happens before “900 years old you reach.”

    MORE: 14 Steps to Be a Smarter (and Richer) Investor

MONEY Warren Buffett

This Is How Much It Costs to Live Next Door to Warren Buffett

Getting to call the Berkshire Hathaway CEO your neighbor won't come cheap.

Billionaire investor Warren Buffett famously still lives in the Omaha, Nebraska, home he bought in 1958 for $31,500.

But the five-bedroom, 5 1/2-bath house that just went on sale right across the street is going for a bit more.

Although it was recently appraised for just under a million dollars, according to current owner Phil Huston, the home’s list price is 10 “A shares” of Berkshire Hathaway stock, equal to about $2.15 million today.

Given that many are willing to pay up for Buffett’s time and former possessions—including one man who paid more than $2 million to lunch with the Berkshire CEO and one who splurged for his old Cadillac—it seems reasonable to think that a buyer might pay a premium to become neighbors with the Oracle of Omaha, says Huston.

“Call it the Buffett factor,” he says.

Huston, who has lived at 225 S. 55th street with his antique-dealer wife Anne since 1994, says the residence—built in 1922—has an interesting history of its own. During the 1950s it was the home of the late Donald Keough, who was not only a long-time friend of Buffett, but also went on to become a top Coca Cola executive. (Buffett, an avid consumer of the soft drink, led Berkshire Hathaway to become a top shareholder of Coke stock.)

The Hustons don’t have any offers on their home yet, but they hope to pique the interest of those visiting Omaha this weekend for Berkshire Hathaway’s annual meeting. Click through the gallery above for more images of the residence.


How Twitter Tried to Convince Us That It’s Doing Really Well

The Twitter logo is shown at its corporate headquarters  in San Francisco
Robert Galbraith—Reuters

Stop falling for this tech bubble trick.

2014 was a very unprofitable year for Twitter TWITTER INC. TWTR -0.43% . The company reported a net loss of $578 million on $1.4 billion of revenue. Even the free cash flow, which benefits from adding back Twitter’s massive $632 million of stock-based compensation, was negative, a loss of $120 million. The fourth quarter was no different than the full year, with both net income and free cash flow soundly negative.

Despite these sobering numbers, Twitter recorded record quarterly profits, according to CEO Dick Costolo:

We closed out the year with our business advancing at a great pace. Revenue growth accelerated again for the full year, and we had record quarterly profits on an adjusted EBITDA basis.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Twitter’s adjusted EBITDA backs out another major expense: stock-based compensation. On an adjusted EBITDA basis, Twitter earned $141 million of profit in the fourth quarter, and $301 million of profit during the full year. Adjusted EBITDA nearly quadrupled in 2014.

If you look at the earnings reports of big, profitable technology companies, you’re unlikely to find EBITDA mentioned at all. I looked at the latest earnings releases for Microsoft, Apple, Intel, Cisco, Facebook, Qualcomm, Oracle, IBM, and Google. How many times do you think EBITDA was mentioned?

Not even once.

There’s a good reason for this: EBITDA is a mostly useless number. EBITDA was a popular metric during the dot-com boom of the late 90s, and I’m seeing it touted in an increasing number of earnings releases today, largely by unprofitable tech companies like Twitter.

A common argument for using EBITDA is that depreciation and amortization are non-cash expenses, and by backing those out, you get something that’s supposed to represent a company’s real cash flow. Warren Buffett, in his 2000 shareholder letter, pretty much kills this argument:

References to EBITDA make us shudder — does management think the tooth fairy pays for capital expenditures?

EBITDA accounts for the earnings generated by a company’s assets without accounting for the cost of those assets. Depreciation may not be a cash expense, but it is a real expense, and ignoring it produces a number that carries little meaning. Charlie Munger puts it best:

I think that, every time you see the word EBITDA, you should substitute the word “bullshit” earnings.

To see why EBITDA can be so misleading, let’s start a business.

The power of EBITDA

I’m going to start a fictional food truck business. I’ll buy one truck in the first year, then add an additional truck each following year. Each truck costs $50,000 and has a useful lifetime of five years, generating a $10,000 depreciation expense annually.

It turns out, I’m not very good at selling tacos out of a truck. Each food truck I own consistently generates $100,000 in annual revenue, but it costs $90,000 to operate, including food costs, wages, etc. Add in the depreciation expense, and my operating income per truck is zero.

No matter — I want to build a food truck empire. I borrow money each year from the bank to open a new food truck and replace any that need to be replaced, paying 6% interest. After 10 years, with 10 food trucks in operation, things are either going very well or very poorly, depending on which numbers you look at.

In year 10 of my food truck business, the company generated $1 million in revenue, a tenfold increase compared to the first year of operation. It was also a record year for profitability on an EBITDA basis. EBITDA came in at $100,000, 10% of revenue, and it has increased every single year. EBITDA also easily covers the $45,000 of annual interest payments.

That may sound great, but net income in year 10 was a loss of $45,000 thanks to the interest on all of those loans. Free cash flow is also negative, since I spent $50,000 expanding my food truck empire and another $50,000 replacing one of my existing trucks. The company is hemorrhaging cash and, unable to even pay the interest on its loans, is on the verge of bankruptcy.

Calculations and chart by author. Free cash flow ignores effects of changes in working capital, but including this would make free cash flow even more negative.

EBITDA has managed to make this unsustainable, money-losing company look like a success story. Not only does EBITDA ignore the cost of the food trucks, which are required to generate any revenue in the first place, it also ignores interest, which is a real cash expense. EBITDA is in no way equivalent to cash flow.

Putting lipstick on a pig

Twitter’s adjusted EBITDA not only excludes depreciation and amortization, which totaled $208 million during 2014, but it also excludes $632 million of stock-based compensation. More than 40% of Twitter’s expenses are completely ignored in an effort to produce a number that makes the company appear profitable.

A good rule of thumb for all investors to follow: Always question the numbers management wants you to see. Companies make up all sorts of non-GAAP, adjusted figures in an attempt to make things look better than they really are. Sometimes, these figures are perfectly reasonable. Other times, like in the case of Twitter’s magical adjusted EBITDA, they’re not.

As Warren Buffett said during the 2002 Berkshire Hathaway annual meeting:

People who use EBITDA are either trying to con you, or they’re conning themselves.

Remember that the next time you’re looking at an earnings report.

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