Buffett's Investments: The Washington Post
In this chapter the author has compiled 9 stock stories and teaches us how Warren Buffett looked at each of them as investment ideas. This is probably the most important chapter of the book as the case studies from this chapter can be used by us in our investment analysis. As we read through this chapter, we will understand various traits that were common in each of the companies that Buffett invested in. Also, each of the case studies is divided into the 4 tenets as described in the previous chapter to better understand why Buffett invested in these companies. We have divided this chapter into separte section for each stock. Strating with the first one:
The Washington Post
Buffett bought the Washington Post during the bear market of 1973. However, the owners then of the Washington Post were not comfortable with an outsider buying such a large stake in the company. Since the beginning of his ownership journey, Buffett does not have a reputation for influencing the company or for a hostile takeover. He likes to work in harmony with the management and hence he assured the promoters of the Washington Post that he would not take part in the day-to-day operations of the company even if he held a majority stake. Let’s now look at why Warren bought the Washington Post via the tenets of his investing style.
1. Simple and understandable business
Prior to owning the Washington Post, Buffett owned a few other weekly journals. His grandfather owned and operated a weekly newspaper. This taught him about the newspaper industry. Although he was a supporter of high-quality journalism, he, however, looked at the Washington Post as a profit-generating machine.
2. Consistent operating history
Buffett was involved in the distribution of the Washington Post during his childhood days when he used to do petty jobs in order to earn pocket money. Thus, the Washington Post has been in business for a long time.
3. Favorable Long-Term Prospects
Buffett believes that the prospects of a dominant newspaper are excellent. In the 1980s, prior to internet adaptability, there were some 1,700 newspapers in the U.S. and 1,600 operated without any direct competition. Owning a newspaper, according to Warren, was like getting royalty through the advertisement of any business that ran in town. Newspapers also have low capital requirements and have pricing power due to distribution moat.
4. Determine the value
The author had derived the value of the Washington Post during the time when Buffett bought it in 1973. He has used the DCF methodology although with a twist. At the end of 1972, Washington Post had a net income of $13.3mn + Depreciation ($3.7mn) – capital expenditure ($6.6mn) = $10.4mn divided by the long-term US government bond yield of 6.81%, giving a value of $150mn. Whereas, Washington Post was available at a valuation of just $80mn in 1972. Hence it was a good buy.
A catch here with the author’s calculation is that he has not estimated the future earnings of the company. Rather he has assumed that there will be no growth in the company’s earnings in the future and that the company will keep on earning $10.4mn for perpetuity. This is a very simplified version of DCF which cannot be used in the practical world as companies face fluctuation in their profits due to business cycles.
5. Buy at attractive prices
As calculated from the above DCF methodology, Washington Post was available at almost half the value and hence was an attractive buy for Warren Buffett.
6. Return on Equity
Washington Post had a return on equity (ROE) of 15.7% when Buffett purchased the stock. This was moreover an average ROE. Over the next ten years since his investment, the ROE shot up to 36% which is supernormal.
7. Profit Margins
The profit margins of the company in the 1960s were 15%, however the company faced the challenge of high wages as there were unions in the press. This led to a sharp drop in the margins to 10.8%. However, the company was able to solve the issue, and by 1988, the pre-tax margins jumped to 31.8%, higher than the 16.9% average margin of the U.S. newspaper industry and 8.6% margin of S&P Industrial Average stocks.
8. Rationality
A rational management is one which participates in efficient capital management. In case of the Washington Post, Buffett was able to convince the management that the change from newspaper to online/ television was a secular change and hence the pricing power of the industry was going to be affected. Hence the company participated in large buybacks and dividends to reward its shareholders. Additionally, Buffett did not sell its holding in the Washington Post even though he was convinced of the secular change, because the company held $400mn in cash holdings and was effectively debt free.
9. The One-Dollar Promise
If the management has optimally invested the capital, then the same is reflected in the gain in the market capitalization of the company over the long term. For the Washington Post, between 1973-1992, it had retained $1.46bn. From 1973-1992, the company gained $2.55bn in market capitalization. Hence, the company was able to create $1.81 in market value for each dollar retained.
