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Buffett And Munger – Secrets To Success That Are Not Talked About Enough

Summary Warren and Charlie Borrow with Pride. To be very successful you have to be intelligently different. Disciplined flexibility is a key advantage. Growing up in Nebraska it is no surprise that I was heavily influenced by Warren Buffett, Charlie Munger, and Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ). There is a lot to learn from the dynamic duo and there is a significant amount of material discussing their words of wisdom. However, there are a few things I have learned from them that are not as widely discussed as I think they should be or can be seen through a different lens. Borrow with Pride Years ago I used to follow an international telecom company called Millicom International. One of their common sayings was “Borrow with Pride” as they wanted employees to learn from and borrow ideas from one another. I had been borrowing with pride for many years before hearing this, but had never put it into those words. Now I have borrowed their saying as a motto in my life and am proud to Borrow with Price. Of course, Warren and Charlie figured this out years ago. It is widely known that Warren started off by borrowing many of the ideas of Benjamin Graham, then learned from Philip Fisher, and of course from Charlie Munger. For that matter, Charlie Munger’s lattice framework is based on borrowing (learning) ideas and concepts from others. Between Charlie and Warren there really have been few original ideas, but they have borrowed ideas from many people. Even looking at many of the companies Berkshire has purchased, both private and public companies, the ideas came from somebody else. For example, Lubrizol was David Sokol’s idea. The idea of borrowing with pride is really taking another angle on what we already know about Warren and Charlie. The reason why I look at it from this angle is because I know quite a number of very smart people that do not like to borrow ideas from others; they have to be original. At a firm I worked for one associate disliked the idea that I followed certain investors and looked into their holdings. He thought we should be original and find our own ideas through other means. There is nothing wrong with finding ideas that are original, but there is nothing wrong with borrowing either. What I think he missed is that the vast majority of frameworks we use are borrowed and the skills we have are learned from others. There is no shame in borrowing ideas from other smart people. Both Warren and Charlie have made a lot of money from borrowed ideas. Different, but Intelligent “If past history was all there was to the game, the richest people would be librarians.” – Warren Buffett To be extremely successful in investing you have to do something that is both different from the majority of investors, yet intelligent. While most of the ideas behind Berkshire Hathaway are borrowed they way they applied the concepts is original in many ways. This is a huge reason why they were and are successful. For centuries people had been investing insurance float, but Buffett and Munger used it differently. By being disciplined with the float they not only were able to obtain cheap leverage, which had a multiplier effect on their investment returns, but were actually paid to borrow money. The conglomerate structure has been around for centuries as well and Buffett and Munger both learned a lot from Henry Singleton who started Teledyne. However, Berkshire is different than Teledyne and was built to be an enduring company while Teledyne was eventually sold . Of course, if you do something different and it is not done intelligently than more likely than not it will be a failure, unless you get lucky. From Buffett and Munger I have learned to both borrow ideas/concepts and try to apply them in a different yet intelligent way. Apply it to yourself Let’s face it, you are not Warren Buffett or Charlie Munger and neither am I. If you try to completely imitate them you will find that you do not have the skills and attributes they do. However, each investor has their own talents and skills. Buffett and Munger talk about circle of competence and that should apply to both the types of companies you understand as well as the skills that you have. You need to know yourself, what skills you have, and strengths you can improve on to become a better investor. You don’t have to know everything as Warren said , “You only have to do a very few things right in your life so long as you don’t do too many things wrong.” Neither Warren or Charlie tried to be Benjamin Graham, Philip Fisher, or Henry Singleton but they did learn a lot from each of these men. What I have learned from Warren and Charlie is not to try to be them, but to learn from them and apply what I learn to myself. Flexible, Disciplined, Opportunistic Often people discuss the fact that Warren Buffett has changed his stripes over time from being more of a Graham net-net investor to a Fisher quality with growth investor. However, I see Buffett differently as I think he is quite flexible. After the financial crisis he invested in Bank of America Preferred Stock and Warrants. I wouldn’t call Bank of America a high-quality growth company. There was also the controversial derivative investments that have worked out well. In the book “Of Permanent Value” by Andrew Kilpatrick he mentions Buffett and Munger buying silver. When Berkshire Hathaway purchases 100% of a company you can bet that they think the company is a high-quality company. However, some of their partial investments have not been. Buffett and Munger are opportunistic; if they see an opportunity they will jump on it. Yet, they are disciplined in that they only invest in ideas they understand and expect to generate strong returns on. What I learned from Buffett and Munger is to be flexible to all the types of investments that I understand, but to be disciplined in my approach and wait for opportunities.

Major Changes In My Retirement Portfolio

Summary I continue to keep skin in the game with my ETF-based retirement portfolio. This year saw two ETFs get sold, a new ETF added, and a change in the portfolio’s weighting scheme. Steps were taken to enhance the portfolio’s dividend yield (with the expectation of a nearly 20% capital gain on one investment). In May 2014, I set up a retirement portfolio (with my real money invested) made up only of ETFs (” 5 ETFs For A Reliable Retirement Portfolio “), which was followed quickly by a modification (” Adjusting the ETF Retirement Portfolio “). The ultimate goal is to construct a portfolio that will: Provide better than 5% yield (annually); Provide a modest level of growth; Be as maintenance free as possible. The initial portfolio consisted of the following five ETFs: SPDR SSgA Income Allocation ETF (NYSEARCA: INKM ) iShares Morningstar Multi-Asset Income ETF (BATS: IYLD ) First Trust Multi-Asset Diversified Income Index Fund (NASDAQ: MDIV ) PowerShares CEF Income Composite Portfolio (NYSEARCA: PCEF ) PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ) PCEF was added to the portfolio in May, to replace iShares Moderate Allocation ETF (NYSEARCA: AOM ), which I quickly got rid of. This is how the portfolio (would have) performed for 2014: 1 (click to enlarge) It was never my expectation that I would outperform the S&P 500 ; my assets were divided between large caps (through SPLV ), bonds ( INKM & IYLD ) and high-yield instruments ( PCEF & MDIV ). That the portfolio kept it fairly close, though, was gratifying. In December I made two changes to the portfolio 2 : I sold both MDIV and PCEF to enable me to add to the holdings of INKM , IYLD and SPLV ; and I added iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ). My reasoning was that neither MDIV nor PCEF were performing up to expectations; if the point of the two funds was to provide dividends, I could find a better yield by switching to REM . PCEF was clearly underperforming, and while MDIV seemed to hold its own, it consisted of holdings in six high-yield areas: REITs, BDCs, MLPs, high-yield bonds, preferred stock and high-dividend stock. A weight on energy stocks struck me as undesirable, given the oil market, so I thought dropping MDIV was for the best. 3 By increasing the holdings in the other three funds, I hoped I would realize an improvement in growth. Stagnation During Early 2015 Over the course of the next five months, the portfolio consisting of INKM, IYLD, REM and SPLV performed thusly: (click to enlarge) Again, I did not expect to keep even with the S&P, but the following graph illustrates the quandary in which I found myself: Somewhat paradoxically, what was holding the portfolio back was SPLV , which is a subset of the S&P 500, which was doing just fine. Perhaps this is somewhat to be expected from a set of companies chosen for their low volatility, but that should not have meant a period of fairly significant underperformance (let alone negative performance). In June 2015, I had the opportunity to examine a new ETF: iShares FactorSelect MSCI International ETF (NYSEARCA: INTF ). This fund seemed to address concerns I had about investing in global or international funds — it focused on roughly 200 companies located in fairly solid, developed nations; the companies were deemed to be good values , of high quality , and having positive momentum . The fund struck me as an excellent tool for investing in relatively safe foreign markets. So, in June, I sold off INKM and IYLD , and added INTF to the portfolio. My reasoning here was that IYLD looked better to be replaced with a larger position in REM (since REM was paying about double the dividend); INKM was where most of my foreign exposure was, but INTF looked to offer better growth opportunity with only slightly less dividend; the Greece situation seemed to be under control and Western European nations seemed to be recovering – and the largest part of INTF is invested in Western Europe. 4 I also considered revamping the weighting of the portfolio. Initially, the holdings were value-weighted, in that I had an equal number of shares of each ETF. This was disrupted somewhat when I dropped PCEF for REM ; REM is far less expensive than most ETFs (currently just over $10.00/share), and I would be able to take better advantage of its ~ 12% (at the time) yield if I doubled the number of shares compared to the other funds. When I reached the decision to sell INKM and IYLD , I decided to switch to an equal-weighted scheme, dividing the portfolio equally between REM , INTF and SPLV . 5 I hoped that these changes would result in a significant improvement in portfolio yield, along with an expected improvement in value growth. The market, however, had other plans. The Summer “Correction” The summer of 2015 was fairly brutal for stocks, which got dragged down by several factors: the Chinese economy looked to be faltering seriously; European nations had their social resources taxed by a dramatic influx of immigrants fleeing civil unrest in Syria and elsewhere in the Middle East; oil continued to be problematic; U.S. political issues continued to threaten increasing the debt ceiling, the Asian trade pact and the Export -Import Bank; the Fed seemed trapped by its earlier assertions that a rate increase would be imposed late this year. And to top it all off, ETFs were soundly trounced over the week of August 17-25. Exactly why the ETF market “misbehaved” may not be completely certain, but despite safety features in place to halt trading at points where the market is distressed, ETF prices seemed to march to the beat of a completely different drummer than their NAVs. The following chart tells the story: (click to enlarge) Between August 17 and August 25, the S&P dropped to $1867.61 from $2102.44 (-11.17%), and the ETF/R portfolio dropped to $10,182.82 from $11,104.26 (-8.30%). Overall, ETF/R dropped 3.74% since June 1, compared to a drop of 4.16% for the S&P. The following chart reflects the performance of the individual ETFs in the portfolio (INKM and IYLD are included for sake of comparison): Everything has been running negative since June, but SPLV only barely so. The drop in value suffered by REM is offset by its > 13% yield. Since Inception, Then… Here is the portfolio’s total return, up to 15 October 2015: (click to enlarge) Not bad, all things (especially August) considered. The current yield for the three funds taken together is 5.97%. Supplementing the yield is interest from a baby bond issued by Phoenix Companies, Inc. (NYSE: PNX ) – Phoenix Cos. Inc. 7.45% QUIBS (PFX). I purchased shares at a discount ($20.91), raising the yield to 8.90%. This raises my portfolio’s overall yield to 6.42%. Long term, redemption of the bond will result in a gain of 19.5% over purchase price (on top of the interest received). 6 What if… ? It may not always be a good idea to compare what one has now to what one might have had, had one not made certain changes; but in the spirit of “due diligence” I did look at what might have happened had I not swapped INKM and IYLD for INTF and larger holdings of REM and SPLV . 7 The following chart compares ETF/R (currently consisting of INTF , REM and SPLV ) to ” ETF/OP ” – ETF/”Original Portfolio” — consisting of INKM , IYLD , REM (with fewer shares) and SPLV : (click to enlarge) The divergence between the portfolios begins after 1 June, when the original portfolio was reconstituted; the difference between the two portfolios is a small — but still noticeable — 73bps . It occurred to me that there was one factor in the reconstitution of the portfolio that I had not yet taken into account: when I switched to INTF and an equal-weight system, I added ETF/R’s earnings from dividends to the proceeds from the sale of INKM and IYLD . The injection of capital into the equation may have tilted the comparison, so I added a third portfolio to the test: ETF/R-A — the portfolio as it would have been had I not infused the additional money (but still equal weighted). The following chart (covering only the period since 1 June) is interesting: (click to enlarge) (Note that the figures in the diagram cover only 1 June-15 October.) The only difference between ETF/OP and ETF/R-A is a hardly negligible 7bps . ETF/R suffered a larger loss, dropping an additional 58bps . From the above, it is possible to infer that the primary cause for the difference in performance between ETF/R and ETF/OP is the additional capital added to ETF/R. Injecting those funds changed them from a static datum added to portfolio performance, into a part of the data subject to the vacillations of the market value of the funds. Just as the extra capital resulted in larger losses during the market drop, however, that capital should yield improved performance as the market increases. 8 Observations It’s not really possible to determine if the switch from INKM and IYLD to INTF and increased holdings in SPLV and REM was a good move or not, in light of the bad summer. The following graph gives a snapshot of the performance of each of the ETFs that have occupied the portfolio: REM is not really to be expected to give much of a performance in terms of value — its function is to provide dividend income, and it does that well. INTF had the misfortune of being added to the portfolio just before the market took a dive, so any judgment of it will have to wait until more evidence is collected. It is paying dividends, however. SPLV was supposed to be the anchor of the portfolio, and it has served this purpose well. In the period from 1 January 2014 through 15 October 2015, the fund is up by 14.08%. By way of comparison, State Street’s SPDR S&P 500 ETF ( SPY ), which closely tracks the S&P 500, is up only 10.59% over the same period. It is possible that I reconsider INKM at some point. Likewise, IYLD . I think the portfolio will end up stronger, however, for the holdings in INTF . It will take a while to see if the shift to an equal-weighted portfolio will have significant benefit, but it does appear to have improved my yield: the greater the number of shares of REM in the portfolio, the more dividends I realize. That’s a good thing. Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from the performance information regarding the ETFs mentioned. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from Yahoo! Finance . Data from any other sources (if used) is cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. 1 I say “would have” for two reasons: the chart begins on 1/1/2014, rather than when I actually started the portfolio, since I built the portfolio over the course of 3 months, from late February into May; also, I made changes to the portfolio in June and December. I discuss these changes in the course of this article. 2 ” The ETF Retirement Portfolio Revisited .” 3 The holdings in REITs and BDCs – both of which are notorious underperformers – didn’t help MDIV’s case. 4 It also has Asian holdings, notably Japan and Australia; in any event, all of its holdings are in developed nations. 5 If you’ve been following me for a while, you might remember that I have been favoring equal-weighted portfolios ever since I examined Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP ) here . Of course, you might ask why I stay with SPLV if I favor equal-weighted portfolios (like RSP’s). Fair enough; I also have a thing about all-inclusive portfolios. I like a fund that uses some finesse to narrow the field somewhat. I shall have to look at this approach in the future. 6 PNX was something of a risk, as the company has been having its problems. However, it was announced on 30 September that PNX had reached an acquisition agreement with Nassau Reinsurance Group Holdings L.P. (according to Zacks Equity Research , here ); this should provide substantial financial security to PNX. Upon redemption, I would see a 19.5% gain on share value, based on the issue price of $25.00. 7 I believe that considering a “what if” scenario concerning PCEF to be unproductive; subsequent yield would have been lower, added shares of SPLV would not have been purchased, and – ultimately – PCEF would have ended up being sold in June, after having lost additional share value. 8 As should be expected; this is, after all, the point of DRIP arrangements: taking dividend earnings and using them to buy additional shares of a holding is intended to augment the growth potential of a stock.

Piedmont Natural Gas: Steady, Reliable Income

Summary Dividend history is incredibly stable – 3 or 4% annual raises for more than a decade. Market area (Carolinas and Tennessee) is one of the bright spots in the United States. Shares won’t double overnight, but they don’t have to in order to reward shareholders well. Piedmont Natural Gas (NYSE: PNY ) is a large, pure-play natural gas distribution company with a wide berth of operations across the Southeastern United States. The utility has been growing steadily, with earnings and the dividend tracking along at nearly 5%/year for the past twenty years. Consistency has been the name of the game here. This measured growth has been attributable to the favorable rate environment along with population growth strength in the Southeast coupled with the buildout of pipelines surrounding the Marcellus/Utica shale formations in the Northeast. Natural gas development and production in the United States has been and continues to be incredibly strong, yielding abundant supply and relatively stable pricing for gas utilities like Piedmont Natural Gas, especially over the past five years. This strong, consistent operating performance has yielded shares that have been less volatile and consistently outperformed the broader utility index. Will the future be as strong as the past? Operating Results Revenue is down, as has been the case for many natural gas utilities. This is because utilities dealing with lower natural gas prices have to pass the vast majority of the associated cost benefits passed along to consumers in the form of lower utility bills. Excess consumer demand from cheap energy rarely offsets the associated drop in revenue. Further compounding top-ine issues, weather has been at best normal and at worst seasonally warm in the company’s service areas. Decoupling agreements with the utility commission and strong local population growth have done their best in managing to keep growth flat. The company’s small but highly profitable non-regulated businesses have also done well, helping to improve overall operating margins over the 2011-2015 timeframe. (click to enlarge) Piedmont continues to invest significantly in its pipeline infrastructure through capital expenditures. This has continued to result in cash flow deficits, most obviously in 2013/2014. The company notes that it is pushing for new regulatory mechanisms such as IMR tariffs and accelerated rate requests to allow quicker recovery of its cash outlays. The majority of these initiatives went into place in 2013 and the company has made significant strides in getting back to cash flow neutral between its operating and investing activities. Unfortunately the shortfalls in 2013 and 2014 almost doubled long-term debt from $675M in 2012 to nearly $1.4B today. At 3.3x net debt/EBITDA, however, the company is only moderately leveraged and will have no problem covering interest expense on this cheap fixed-rate debt (blended rate is 3.85% fixed rate). While negative consistent overspending in the cash flow statement is generally a sign of mismanagement, in this case it was simply the case of a company investing in its non-utility power generation service delivery projects. Going forward, I expect cash flow shortfalls to be small and investors need not be concerned yet. Conclusion I view Piedmont Energy as an excellent choice in its peer group compared to overvalued alternatives like Atmos Energy (NYSE: ATO ) ( analyzed here ) or lower yielding options like Southwest Gas (NYSE: SWX ) ( analyzed here ). Dividend growth has been incredibly consistent, plugging along at either 3 or 4% increases every year for more than a decade. At a 3.22% yield as of today, the income being thrown off isn’t anything to sneeze at either. Investors might find themselves falling asleep if they hold the stock in their portfolios. For income investors, that is quite often a good thing rather than a bad thing. While I wouldn’t go running to pick up shares at current levels, current shareholders are likely quite happy with the results they’ve been getting and will likely continue to get. I’m not going to disagree with that sentiment. If you’re long, keep on holding and enjoy what is likely to be one of the most stable companies investors have access to in publicly-traded markets. Share this article with a colleague