Value Investing – Page 52

On the Berkshire Hathaway Buyback

Posted on 27 September 2011 by David Merkel

He finally decided to do it.? He’s going to buy back stock.

Don’t get me wrong.? I am not a critic here, nor an admirer; I am just an observer.

Buffett is a rational guy. Hyper-rational.? More rational than I am.

He thinks that his stock is a good buy below 1.1x unadjusted book value.? I don’t know that he is right there, but I give him and Whitney Tilson the benefit of the doubt.

My friend Josh Brown said:

Full disclosure, I’m long Berkshire Hathaway B shares for client and family accounts and have been forever and a day, so of course I’m thrilled with the news this morning.

Normally I detest buybacks.? The primary reasons are:

They usually occur at the top of a cycle and are a sign of a top when they peak en masse

They usually are used to mask massive stock option issuance to enrich insiders while doing nothing other than offsetting dilution to shareholders

They are financial engineering and are thus suspect

They are inferior to dividends

They can be a sign that management has no idea what to do to grow or improve a business

But Buffett is not masking stock issuance, he is purely concerned with building shareholder value and sees an investment in his own stock (and hence the various companies he owns) as the best use of capital.? This is very different from when Cisco issues 50 million in options and then announces the requisite buyback that would offset it.

As far as buybacks go, this is a good one, but the question remains, how good is it?? If Buffett had better uses for cash, he would not be buying back stock, and this is at a time when all equity valuations are depressed.

To me this indicates that Buffett does not have any large places to deploy cash superior to the cost of capital of Berkshire Hathaway, which is pretty low, aside from investments with an inadequate margin of safety.

That doesn’t mean the whole market is overvalued, but it does mean that a bright guy like Buffett anticipates no more large productive places in the near future to put large amounts money to work than by shrinking his own balance sheet.? Not a good sign for the economy.

He could sit on the cash and wait.? He has done it before at valuation levels like this in the mid-2000s.? It’s not as if the compression in valuations has only hit BRK.? Many companies seem cheap now on a current earnings basis.? This is especially true of many insurers, of which BRK is one.

Buffett was willing to expend cash to make a superior offer for Transatlantic Reinsurance at a little more than 70% of book, and 8x forward earnings.? Granted, that would have only deployed $3B+, and given him more float to invest.? Still, it shows the cheapness of the environment.? But perhaps there is more uncertainty around the valuations of less well-capitalized firms than BRK, so buying back higher quality BRK stock is preferred to buying in the liabilities of companies of which Buffett has less knowledge.

There is the more radical act: Buffett could buy the stock outright himself.? He has significant personal outside holdings; why not sell them and buy more BRK?? That would make an even greater statement then the buyback.? An insider buy from the ultimate insider at BRK would say a lot more than shrinking BRK’s balance sheet through buybacks.? Think of it this way: Buffett’s interest in BRK increases 4 times as fast if he uses his own money versus the corporation doing the buyback.

As an investor in insurers here, I have better places to put money than BRK.? I like BRK, but the whole industry is cheap amid the uncertainty of the macroeconomic environment.? BRK deserves the higher valuation because it is a diversified industrial/insurance conglomerate, and not merely a despised insurer.

I will sit and own my cheap insurers because their cash flows will more than justify higher valuations eventually.

PS — there had to be a better way to do this.? BRK could have struck a deal to do an accelerated share repurchase, without jolting the market, and pushing up the price of a repurchase.? Perhaps it could have been done by simply announcing that the Board has approved buybacks, should the price ever become favorable for that, and then repurchase slowly and quietly.

Reinsurance Group of America

Posted on 24 September 2011 by David Merkel

I read an article by Zacks on RGA.? I thought it was poorly reasoned.? Here’s what I wrote as a comment:

“However, the primary factors to our Neutral recommendation are Reinsurance Group?s reliance on availability for affordable retrocession. The company had increased the maximum amount of coverage that it retains per life in the U.S. from $6.0 million to $8.0 million. This reduces the amount of premiums it pays to retrocessionaires, but increases the maximum effect a single death claim can have on its results, and therefore may result in additional volatility to its results.

Also interest rates are likely to remain low in 2011 and spreads narrow further. We expect to see additional pressure on the Reinsurance Group?s investment income. Moreover, management?s conservative positioning of the investment portfolio is expected to exert pressure on yield.”

I hate to say this, but you don’t know life reinsurance that well if this is your reasoning. Interest spreads are not a major factor in RGA’s profitability. Also, the retrocession cartel charges an arm and a leg for coverage. The earnings will be more volatile, but they have always been volatile with RGA. The time to buy is after a bad quarter, because mortality is random, but RGA underwrites well.

Let me get this straight. This company has a big moat; it’s part of the life reinsurance oligopoly. It’s trading at a forward P/E of 6, a trailing P/E of 5.5, and 65% of unadjusted book. This company is a leader in its industry globally, and you rate it a hold?

Let me tell you a secret. You almost never lose on companies with little debt, trading at single digit P/Es, and trading below book, conservatively stated.

I own this stock, and so do my clients.

RGA is trading cheap enough that I am considering making it a double-weight in my portfolio.? It is a single-weight at present.? It is genuinely rare that one finds such a quality company with protected boundaries trading at such levels.? There are five companies that dominate life reinsurance globally, and in my opinion, RGA is the best, though they are a close number 2 by most measures of market share.

I don’t like writing about individual companies, because when you are right, one person praises you.? When you are wrong 10 people criticize you.? But for all that I simply say that I am long RGA for myself and my clients.

Advice to a Friend, Again

Posted on 22 September 2011 by David Merkel

A friend of mine asked me the following:

I read an article or a comment from a blog that inked to your sight.? the statement was akin to this. ” The market is dead.? The lack of growth over ten years shows the deadness of the market.? If the market had kept pace with inflation over the last ten years it would be at 32,000 not the 11,000 we see today.”

I am not all that concerned that this is a true statement, nor am I convinced that their is any better long term investment then a good market strategy.? but I do not have the wisdom to know how to answer this sort of claim in my mind.

The Other Question also comes from a blog that linked to your site:? http://pragcap.com/the-importance-of-understanding-macro

“Whitney Tilson?s latest monthly letter provides us with some insightful lessons for the current market environment. ?Regular readers will know that I believe there is no such thing as a one size fits all investment strategy or a holy grail approach. ?Instead, investors must understand the macro environment and apply the correct strategy to fit that particular environment. ?That micro approach could involve buy and hold, trading, value investing, etc. ?But the likelihood of success using one strategy in all environments is unlikely. The current turmoil and unusual asset class correlation is making for a very difficult environment for value investors. ?Tilson explains (thanks to Zero Hedge):”

Later on he states the following: “Value investing might not be dead (it?s certainly not dead for those who have the ability to implement it in the actual way that Warren Buffett implements it ? no, not the ?buy and hold? myth that Wall Street has sold to everyone), but we can be almost certain that it?s more important than ever to understand the macro. ?If there?s one great lesson to learn from the recent turmoil that should be it?.”

Is the above author stating the difficulty of being a value investor, or is this a man trying to validate his own lack of plan or strategy in a difficult market?? Besides a difficult month for some value investors what is their augment against it.? Would your “bloodless” strategy of quarterly trading be the answer their the accusation of the “buy and hold myth.”

With respect to the tripling of the index level due to inflation, that seems really high to me, akin to a 10% inflation rate.? I think that government inflation statistics are biased low, but by 1-2%/year not 6-8%/year.

On value investing, I rely on Ben Graham’s dictum that the stock market is a voting machine in the short run, and a weighing machine in the long run.? Periods of high correlation where the voting machine dominates eventually go away, and when they go away the weighing machine comes back and patient holders of cheap quality stocks get rewarded.

Value investing has gone through far deeper periods of underperformance such as the one in the late ’90s where many famous value investors got fired, just before the paradigm was about to shift, and value outpace growth by more than the underperformance.

“Buy and hold” is always lionized in a bull market, and castigated in a bear market.? That’s normal.? I grew up in the ’70s watching Wall Street Week with Louis Rukeyser, and at that time, traders were dominant in a static market.? That was not true in the ’80s and ’90s.

My quarterly trading strategy strikes a balance between too-frequent trading that most mutual fund managers do, and the never trade strategies that those who misunderstand value investing do.? Most investors trade at the wrong times, giving up on a stock merely due to bad performance, or buying because it is fashionable.? But if the business is fundamentally sound, it can be held through periods of weakness, and even add to the position.

That’s what I do, and it has worked well for me.? May it work so well for my clients.

I lead a finance class for church.? I think we have talked of it before.? I do not deal much with investing. Mostly I work with cleaning up the personal finances of the families.? Paying down debt, increasing savings, Setting and living below your income, budget, basic investing, using your tax shelters, and avoiding risky investments.

I have a family who some years ago purchased $8000 worth of Microsoft stock.? This has over the course of their holdings dropped between $8-10 a share.? Their financial situation requires cash, cash they do not have.? They need to pay off debts, and their current income gives them very little wiggle room to pay extra on debts.? They asked me what to do with the Microsoft stock, that is now down about $1500 from when they purchased it.? Microsoft stock has remained at a price of $23-29 a share for over a year now.? with the average being somewhere around $24-27 My thoughts have been: That the stock has corrected for the time being and

$25 is probably the true value.? IF $6500? would make a big diffrence in you budget, let you pay down alot of debt and free up some extra cash in your budget to pay off other debts, then sell the stock now.? $1500 is a cheap price to pay for a not so wise investment decision, if it can be use to improve your overall financial standing.? I told him he might ask his broker to sell as soon as it hits $26.

I have however read that Microsoft is a company that has put up good sales and profits in the past few years and that their stock price might be well undervalued.? should I encourage him to hold or sell.? Not asking you to predict the future, simply wanting to get counsel on the advise I have given.

If you think this is good advice let me know.? He is able to get by without the funds immediately, but it will be best if he sell them and use them eventually.

Microsoft is a test for value investors.? What do you do with a company that is cheap on a price-to-earnings basis, but tends to waste free cash flow on foolish acquisitions, investments, and stock buybacks?? My view is that you reject Microsoft; there are better things to buy.

But what of the decision of Microsoft versus cash?? Look, one of the first principles of investing is never invest what you can’t afford to lose.? If you might need the money to spend in the near term, don’t invest it in stocks.

Reconsider my article, Build the Buffer.? Until someone can meet all cash needs easily, including small disasters, he should not be investing in stocks.

With that, I would say that he should sell the stock to the degree that he needs liquidity.? Ability to pay cash in advance is worth far more than equity market returns.

Value Investing and Financials

Posted on 15 September 2011 by David Merkel

Disproportionately, value managers are buyers of financial stocks.? This is a result of index construction, because financials trade at relatively low multiples of book value.? Financial stocks led the rally from 1987-2007, and for the most part, it was a good era for value investors.? Value investors tend not to focus on macro concerns; they just want to pick good stocks.

But what the value managers did not appreciate was that a lot of the outperformance of financials stemmed from the willingness of the Fed to engage in a reckless monetary policy that never allowed recessions to clear away the bad debt, and thus the debt/GDP ratio kept on building.? Along with that, poor bank regulation, led by the Fed, drove a decline in underwriting standards.

Well, no surprise that value managers did badly 2007 to the present.? And they will still do badly as debts are deflated, to the extent that they own banks.? There will come a time to own banks, but I think we have to go through one or two more macro-shocks before overall debt levels are reconciled.

I own no banks or REITs.? I own a number of insurers, all of which are conservatively managed.

Eat Your Own Cooking

Posted on 9 September 2011 by David Merkel

When I manage money for my clients, my own money is on the line along with them.? That’s the way it should be.? I try to give clients a clone of my portfolios whether on bonds or stocks.? This aligns my interests with theirs, because I want to make money over the long run on my assets.

This post is spurred by a post at the Wealthfront Blog, where he cites a Morningstar study where only 40% of mutual fund managers invest alongside their investors. Now, some of that is explainable because the asset class of their funds would not be a complete asset management strategy.? But it does not explain why they don’t have any significant amount invested there.

At one firm that I worked for, there was a rule: you could buy anything so long as the firm had first dibs on buying what you wanted to buy.? Once the firm was done buying, you could buy your idea.? Same thing for selling.? The firm must sell first, and only after that could any employee sell.? If you are not trading in lockstep with your clients, you must trade behind them.? No front-running.

But personally, I prefer managers that have the same incentive as investors.? Why? It makes them manage to normal risk levels.? Hedge fund incentives, unless there is some clawback for bad future performance, or that performance fees must be reinvested in the fund for a number of years, incent hedge fund managers to swing for the fences.? You can make a lot in a really good year, and receive your ordinary fees in bad years, without taking any losses.

My experience was when I was one who hired equity managers that the value shops tended to have large amounts of their personal wealth invested in their funds.? Why?? One, they believed in what they were doing.? Two, value investing tends to self-correct over time.? Three, value investors don’t trade as much.? They are typically holding investments they would be comfortable holding for a long time.? Four, there was an ethical idea of “we eat our own cooking.”? They wanted incentives aligned 1:1.? I win, you win.? You lose, I also lose.

This article is dated, but most of those that eat their own cooking are value-oriented managers.? This article is another example, but note that the excellent Vanguard does not require managers to invest in their own funds.? Part of that is the bond complex, and also that some of their equity funds are multiple manager funds.

As for me, I have over 60% of my net worth invested in my strategies, and over 80% of my liquid net worth.? I believe in what I do.? Granted, value investing has not been rewarded recently, but over the long haul, it is usually more than adequately compensated.

Industry Ranks September 2011

Posted on 5 September 20115 September 2011 by David Merkel

I?m working on my quarterly reshaping ? where I choose new companies to enter my portfolio.? The first part of this is industry analysis.

My main industry model is illustrated in the graphic.? Green industries are cold.? Red industries are hot.? If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted??? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

If you use any of this, choose what you use off of your own trading style.? If you trade frequently, stay in the red zone.? Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?? Why change if things are working well?? I?m not saying to change if things are working well.? I?m saying don?t change if things are working badly.? Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.? Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then.? This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.? It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and to a lesser extent Reinsurance, particularly those that are strongly capitalized.? I?m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle ? I am not interested there even at present levels.? The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their ?regulators.?

I?m looking for undervalued and stable industries.? I?m not saying that there is always a bull market out there, and I will find it for you.? But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.? I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.? The red zone is pretty cyclical at present.? I will be very happy hanging out in dull stocks for a while.

Notes on Industries I will not Invest in

Banks & Thrifts
Housing; Building Materials

I will not invest in these industries for not because they are still in oversupply. Until debt levels normalize these are not places to invest.

Entertainment
Gaming
Medical Services (Some)
Newspapers

As a Christian, I avoid industries that are harming our society.? No gambling, abortion, most entertainment, and most newspapers.? You may disagree with me here, but that is the way that I invest.

But as an aside, this is not much of a sacrifice.? Companies that are popular in society are rarely value stocks, and so I almost never toss out a name for ethical reasons.? The valuations of unethical stocks are almost always too high.

On High Correlations

Posted on 31 August 2011 by David Merkel

There have been a lot of articles written recently about a high average correlation level in the stock market.? I want to take a stab at explaining what it means and implies.

A few notes before I start.? First, remember that cash doesn?t enter or leave the market when we buy or sell.? Cash enters the market when new stocks, bonds, etc., get issued in exchange for cash.? Cash exits the market when stocks, bonds, etc., get retired in exchange for cash through buyouts, maturities, etc.? Second, when we buy or sell, the price changes based on whether buyers are sellers are more motivated to buy/sell the asset and sell/buy cash.? In the short run, even the amount of cash doesn?t change, aside from what the brokers and market-makers scrape off.

Note that this applies to ETFs as well.? Even as they grow, they suck in more of the stocks/bonds that they index, but after fees (more scrape) they are just shells, holding vehicles for assets.

Third, there are two reasons why assets can be highly correlated.? The first reason is that the business performance is geared to the same driver, for example, the expansion of credit.? The second reason is that the current and future ownership has similar motives for each asset, and trade each similarly.? The first is Ben Graham?s weighing machine, while the second is the voting machine.? The second reason is more relevant for what we are experiencing today.

Fourth, remember that correlation is not the same as beta.? Stock A always moves half as much as stock B.? The correlation is 1, but the beta versus B is 0.5.? Just because correlations are high does not mean every stock is moving the same amount.? It does mean that they are almost all moving in the same direction at mostly consistent relative amplitudes.

The preliminaries are done.? The most important aspect of my preliminaries is that we are likely dealing with Ben Graham?s voting machine as the causative factor for the high valuations.

Okay, now think of stocks and other assets as dependent on the time horizons of their investors.??? If the time horizons of investors are predominantly long, correlations on assets should be low in the short-run, because investors don?t make decisions to trade off of short-term macro factors.? But when a large part of the investor base is skittish and is always running to or from the latest bit/byte/bite of data ? that leads to high correlations.

ETFs aren?t necessary for high correlations, but they seem to help the process by creating easy ways for people to implement decisions that are a simple idea.?? ?I want financials, I don?t want energy, buy the long bond, sell gold.?

Thus high short-term correlations indicate a momentum mindset in the investor base.? Momentum investors are the ?weak hands? of ownership.? They don?t have much of a balance sheet, and so their decisions are quick and correlated with short term price action.? The strong hands have balance sheets, or are long-term minded, and can ?buy and hold? or ?sell and sit on cash.?? That takes a lot of fortitude, particularly in the present environment.

In an era of high correlations, I have two things to say:

1)????? When the voting machine is running hot, pay more attention to the weighing machine ? the fundamental values that drive long-run investing.? Pretend you are Seth Klarman, Warren Buffett, or if you can?t imagine that, pretend you are me, and aim for the best over the next three years.

2)????? In general, markets are near short-term peaks when the level of momentum investing is high.?? Volatility tends to be high as well.? Volatility is inversely proportional to time horizon. (I.e., the longer you aim for in investing, the less you care about short-term volatility.)

Thus my conclusion is this: now is a time to pay attention to fundamental values.? Ignore the noise and protect your capital.? I know this sounds too simple, but when correlations get too high, act against the direction of the market.

PS — still don’t have power back from Irene.? Pray for us.? I get my work done at a backup site.

On Long Only Equity Investing in Bear Markets

Posted on 22 August 2011 by David Merkel

A reader sent me the following question:

Hi David, this is shall be link to your impossible dream part 2 question.

You mention in the article date May13 that we are probably at #4 part of cycle (looking back great called) Where are we in the part of the cycle? ( I would assume we are in #5) if that is the cast..why you added large 5 of your cash in this sell off? (for trading or for investing) Hope I am not asking too much since I am not a client, only long time reader whom respect your opinion.

Here’s the article he was referencing.? There is a tension between my equity management and the switching strategy I proposed in the first Impossible Dream question.? If we are in a market where we should be allocating asset to safe areas, why am I buying more equities here?

It’s a question of time horizon.? The switch model tells you what will do well for the next month.? I am playing for longer horizons.? That’s why I have my seventh portfolio rule:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

My best purchases occur in bear markets.? I buy things that are safe but way out of favor, and they rocket back when the market finally turns.? That adds a lot to my alpha, which is more than the advantage of switching, historically.? That’s why I average down in bear markets, if the thesis behind the investments is still valid.

As for what phase we are in, I would say 5 or 6. Cycles aren’t neat.? In this case, we don’t have a lot of defaults, but we do have a lot of negative momentum in equities. In four months we have moved from top momentum, top valuation, to bottom momentum middling valu1ation.? That is pretty deep in the don’t buy stocks region, but it often offers the best opportunities to long only investors, if one is buying for three years, rather than one-to-six months.

So I continue to buy equities that are attractive, even in a market where bonds might be favored in the short run.? As for my clients, it is a question of investment horizon.? Short-term: bond strategy.? Long-term: equity strategy.

In general, I aim for the long term.

That’s Mister Buffett to You, Lady!

Posted on 20 August 201121 August 2011 by David Merkel

In my e-mail, I received this tawdry message:

Hi David,

Why is every so in love with Warren Buffett and his financial advice? He used to be a great investor. Not anymore.

Here’s a good article I saw on it from a newspaper in Oregon while I was on vacation there.

http://www.salem-news.com/articles/may182011/warren-buffett-bg.php

That’s Mister Buffett to you, lady.? The garbage article you cited doesn’t have the faintest idea of what Warren Buffett does.? Warren Buffett is not a mutual fund manager, he runs a conglomerate with a real balance sheet and real profitability.? With his friend Charlie Munger, they are wiser than 99% of all the investment advisers out there.? I have my criticisms of Mr. Buffett, but they regard ethics, rather than talent.? Warren needs to repent, he doesn’t need more talent.? There is a difference.

But as for the lousy article, what has the S&P 500 earned over the last ten years — around 1%.? Guess what, of all the big stocks that BRK owns, they have done better than that.? It is irrelevant to cite companies so small that it would not make a difference to BRK if they took a position at favorable prices.

The greater problem is that the article does not understand what Berkshire Hathaway is.? It is an insurance company that owns a lot of businesses.? Whole businesses, not parts of them.? That is 80% of what he does, the rest is like managing a huge mutual fund.

Think of Buffett as a private equity manager with a reputation for not intruding on acquired company cultures.? He is the best place to sell a profitable business to where you want to leave the people you employed intact.

That is a clever niche strategy for private equity.? Give the Buffster some props!

Warren Buffett is deservedly one of the greatest investors of all time.? He made the transition from hedge fund manager, to CEO, but really an investment manager, to CEO of a conglomerate.

Those are three different skills, and Buffett has proved adequate to meet all of the challenges, even after reaching “retirement age.”

I tell you, avoid the envy of articles that want to downplay the results that Buffett has achieved.? He is a master, together with his team, and more than able to manage his company well.? Ignore the naysayers who don’t get it.? Listen to value investors.

The Folly of Large Acquisitions

Posted on 20 August 201121 August 2011 by David Merkel

One of my portfolio management rules deals with use of free cash flow.? I have a hierarchy of how I would like managements to use cash and free cash flow:

Pay down debt; eliminate preferred stock.
Grow existing business organically.
Do small acquisitions adjacent to what the firm is doing, that improve marketing efforts, technology, lower costs, add new geographic markets, add complementary products and services, etc., and then grow those organically.
Buy back stock when it is under the conservative estimate of what the company is worth.
Pay dividends at a level where you can grow them in the future at a reasonable growth rate.
Do a large acquisition that does not materially change the business model, at a fair price.
Do a large acquisition that does not materially change the business model, at a sugar daddy price.
Buy back stock at the current market price regardless of valuation.
Do a large acquisition that materially changes the business model, at a fair price.
Do a large acquisition that materially changes the business model, at a sugar daddy price.

In one sense, aside from step one, this list goes from hardest to easiest.? There are many who think they can add value easily through financial engineering.? Financial engineering means more debt, and that is what led us into this crisis.? I like the companies I own to run with a reasonable margin of safety, but not a huge margin of safety.? Financial engineering is the easiest strategy around, and the rewards of using it are limited.

It’s hard to grow a business organically, particularly in an environment like this where demand is not growing.? The best managers still find ways to grow, without resorting to huge mergers.

Small acquisitions can be very wise for large companies, if they can use the new resources to improve their overall organic growth.

But that’s not the way that lazy, self-aggrandizing CEOs think.? “We need more scale.”? So overpay for a competitor.? For similar companies, there are always cost savings, perhaps some market power, but rarely any other advantages.? Realize the government will be watching more closely, and that there will be some intra-firm rivalry for a few years.? I’ve been there, and I know.

What’s worse is when the CEO decides for a large change in strategy in order to grow faster, and pays a sugar daddy price for a rapidly growing company in a very different business, where the synergies with the existing business are questionable.

I avoid companies that do big acquisitions, unless it is like Buffett, where he does not overpay, or like Exxon/Mobil, where the companies are so similar the it does not matter.

Thus the foolishness of Hewlett Packard.? They had a great culture, and lost confidence in their ability to innovate.? They brought in a series of poor managers — Fiorina, Hurd, Apotheker… it would have been better for the company to sell their PC division to Compaq, rather than buying Compaq.? Hurd manipulated the accounting results.? Apotheker has scores to settle, and wants to beat Oracle, though beating Oracle might have been core for SAP, it should not be for HPQ.

Avoid buying companies that are acquisitive; it is a road to losing money.

Full Disclosure: long ORCL