How I Invest My Money (Capital)

First – a technicality. Money is for spending. Capital is for investing. Capital can only spent to purchase goods or services five years from today. Money is any currency you plan to spend within the next five years. Money includes provisions for emergencies. No, you do not know the amount you will spend on emergencies, but you will have unexpected expenses for which a healthy provision should be made. Do not become caught in down market (think March 2020) with need to liquidate assets.

Stocks are where I invest most of my capital. In a more typical market environment, I would allocate 15% of my portfolio to U.S. government securities. To gain exposure to the stock market I have long positions in individual company stocks; short positions in put option contracts for high quality businesses; long dated call option positions. To generate additional income from several businesses in our portfolio, I occasionally sell covered-call options.

My grandparents began a small dairy farm after Grandpa returned from Europe after suffering a hernia in World War II. Consistently investing the proceeds of their farm, they grew their farm from a handful of cows and 40 acres to over 100 milking cows and another 100 or more young stock while harvesting crops on over 500 acres. When they sold their herd in 1980, my grandparents became investors in the stock market and more significantly in the fixed income investment market. Grandma never sold her assets but she focused on income producing investments and reinvested the proceeds of her investments whenever her broker called with an idea she liked.

The most successful single equity investment Grandma made was a small Minnesota-based bank that was subsequently purchased Wells Fargo (WFC). The cost basis for my grandparents’ WFC was about $1 per share. We sold some of the WFC stake around $55 per share and the rest for about $45 – if memory serves. More notable: annual dividends were more than the cost basis.

My goal is to own companies that consistently grow their dividends to eventually earn more in annual dividends (per share) than our original cost basis per share; just like Grandma. To identify prospective companies I have subscriptions to investment newsletters (at the moment only from The Motley Fool, TMF) and I follow the Buy List published by Eddy Elfenbein; I read others, but Eddy and TMF are the two I trust with my capital; I also consider the target price provided by JP Morgan through my brokerage account.

From the recommendations from TMF and Eddy’s Buy List I have established a list of 18 companies core to our portfolio and all others are considered auxiliary positions. Two core positions (Berkshire Hathaway, 5.3%, and Amazon.com, 7.4%) can maintain up to ten percent of the overall portfolio but other core companies can appreciate to around 6-8% before I plan to trim their stakes; I plan to trim stakes in auxiliary companies that exceed five percent. In 2016, I bundled Visa, Mastercard, PayPal to add exposure to all three companies but at 2/3 ratio of normal positions.

At present, eighty percent of our portfolio is in companies’ stock; we have another 0.5% in long-dated call options contracts. Our cash position has fluctuated between 10-20% but fluctuates based on the number of short positions in put option contracts we hold.

When interest rates went to effectively zero, we sold all of our fixed income government securities to harvest the gains and use the capital in more productive investments. David Swensen, the famed Yale endowment manager, advised readers of his book, Unconventional Success, to avoid corporate bonds and we were rewarded for heeding that advice before the market stabilized this spring. Corporate bonds sold off while our government securities appreciated.

Short positions in put option contracts of intriguing businesses provide income while waiting for market prices to become more attractive. I usually look for contracts with strike prices 15% below the market and offer the option market a premium of at least 15% annualized (premium/strike price).

We use the long-dated option market to take speculative bets on interesting companies without established businesses or track records as public companies. I made a bit of money on Slack contracts earlier this year; we made roughly $1,000 on $585 invested in a Planatir contract held for just a few days; we lost money on a BlueBird Bio contract earlier this year; and we currently hold contracts for Hawaiian Holdings and Real Real (the later for a second time this year following a profitable position earlier).

Underlying all these tactics our strategy is to own strong businesses for many years. We’d love to buy a business and never sell it.

Preview: How I Invest My Money

Josh Brown and Brian Portnoy wrote a compelling new book - which I have yet to read but plan to read soon -that publishes essays by 25 financial professionals that share how each invests his or her own money. From what I’ve heard, “How I Invest My Money” (HIIMM) is a quick and easy read that pulls the curtain back to reveal financial professionals are not so different from everyone else. Everyone struggles to control his or her emotions when faced with market turmoil and HIIMM shares how these pros attempt to balance emotions and opportunity.

This site and HIIMM share a similar purpose: to share personal investing insights and methods. As I have not recently updated my investing strategy and tactic on this blog this post is designed to force me to reread what I wrote, analyze how my approach has changed, and report inconsistencies and evolution.

Writing Puts to Attain more Favorable Cost Bases

Ever hear of picking up nickels in front of a steam roller? Investing parlance uses this metaphor for a strategy I have been using for several months - and it is usually as dangerous as it sounds (significant risk for a mediocre return). Option markets allow investors to buy (or sell) the right to buy (or sell) shares of an underlying equity security (stock of a company).

A Call (right to buy) grants the owner the ability to buy stock at a given price any time before a designated date (the Strike Date). Owning a call option is similar to buying an equity stake in a company, but the price an option is more volatile than the underlying shares and requires less capital while allowing the owner to control a larger stake in the business.

A Put (the right to sell) is basically an insurance policy against a fall in the price of the underlying company. By granting the owner the right to sell at its strike price, a put allows the owner to sell at a price that may be higher than the market price.

Using puts with a strike price that is less than the market price, I earn a premium (the cost of the buyer’s insurance) by agreeing to buy if the market price falls. Because I’d rather buy an ownership at a price below market, selling put options earns income while I wait for a better price of a company I want to buy. When markets reacted to the pandemic earlier this year, many of my put options were exercised and took ownership in several companies like Square and ResMed.

Because I only sell puts for companies I want to buy, the steamroller in my case is a discounted cost basis for a company I admire.

Win the Small Talk at Your Holiday Parties

Your cousin has an inside tip on the next hot biotech drug. Your brother-in-law will not stop bragging about his investment in a new crypto-currency that will “totally disrupt Bitcoin.” Your uncle insists gold is still the best investment. We all have had similar encounters at holiday parties, and not much success has been generated from this banter. Investing success is earned through discipline, patience, and not chasing the trends and tips shared by novices over a cup of eggnog.

Sound investing advice, in general, does not inspire engaging conversation. Warren Buffett, the patron saint of investors, has often counseled the key to successful investing is minimizing mistakes. Want to be the life of the party without perpetuating poor investing behavior? Mention your investment in Netflix is up more than 50% year-to-date and deftly transition the conversation to “Stranger Things” or that mesmerizing documentary you cannot put out of your mind. My go-to move is to bring a card game like “Cards Against Humanity” or “What do you Meme,”  and an impromptu game of charades is another means to avoid speculative investing conversation (pro tip: use these ideas escape controversial political discussion, too).

If you cannot avoid a conversation about speculative investments, smile, nod, and remember the following:

• Invest in sound businesses with an economic advantage over the competition; don’t over-pay; buy when others are fearful, but sell when others are greedy.
• Before individual investments are selected, investors would be wise to create a personal budget that allows for expected expenses for the next five years and contingencies for unexpected events.
  • Funds allocated to planned life events within three years should remain in cash;
  • Funds reserved for events three to five years away should not be invested in assets more volatile than short-term government bonds;
  • Equities are appropriate investment vehicles for long-term goals like retirement or your toddler’s college fund (five-plus years hence).
• Your portfolio’s asset allocation must be designed based on your ability to stay the course during volatile market cycles; if you cannot withstand the urge to liquidate after a twenty percent decline, your appropriate portfolio targets should be more conservative than Buffett’s standard 90-10 stock-cash portfolio.

The way to win the holiday party investing banter is to maintain your investing discipline. Only indulge these whims if your portfolio has a manageable allocation for speculative investments. So drink your eggnog,  smile politely and remember success results from patience, planning, and discipline, not an idea you uncle shared after two too many.

"Don't Get Down on Yourself"

“Don’t get down on yourself.”  Today, my morning meditation focused on this quote from Gary Vaynerchuk, and it was directly applicable to a recent conversation with my wife about my portfolio management experience. 

Yesterday, while speaking with my wife about our portfolio returns over the past 16 months, I made a self-deprecating comment regarding how a fully-invested portfolio would have fared. The cash balance of our “Farm Portfolio” is roughly 19 percent of total assets, and the cash drag has been especially unfortunate during such a prosperous period for the market. 

Since early June 2016 through September 12, 2017, the dividend-adjusted return for the Vanguard S&P 500 Index ETF (VOO) is roughly 21.7% (data source: Yahoo! Finance). Over the same period, our portfolio has appreciated 23.7% before applicable taxes. Our small stake in Shopify (NYSE: SHOP) has just become a triple (+200% return), but would have been a four bagger (+321%) had I bought it on June 2, 2016 (data source: Google Finance). Our Align Technologies (NASDAQ: ALGN) position is within arms-reach of a double (up 97%) but would have returned 137% had I bought on June 10, 2016. 

Were I to ignore Mr. Vaynerchuk, and lament what might have been, I would be left depressed or defeated. Instead, I will learn from my experiences and move forward as a more rational investor. Going forward, I will do my best to, as GaryVee recommends, leave emotion out of decision-making and maintain a disciplined approach to investing.
 

Investing for Dividend Growth: Good for Your Stomach and Good for Your Portfolio

Capital gains get all the hype, but dividends may be a better solution to grow your portfolio. This past weekend I watched an episode of Wealthtrack in which host Consuelo Mack interviewed Hersh Cohen about his long-term investing success based on ownership of companies that consistently grow their dividends. Dividend-growing companies are generally more attractive investments, and their less volatile nature may prevent individual investors from beating themselves by succumbing to reactionary forces in response to market swings.

From 1/31/1987 to 12/31/2016, dividend growers returned, on average, 13.8% with lower volatility (14.5%) while dividend paying companies that do not increase their dividend returned 10.1% with 17% volatility and companies that do not pay dividends 7.4% with 24.3% volatility.

Cohen discussed why he is constantly looking for the next dividend aristocrat. First, business managers who are committed to returning capital to shareholders have less capital to allocate to ill-timed share repurchases and material acquisitions of unrelated businesses. Capital allocation is challenging, even for the highly-talented executives. Cohen believes shareholders should focus on capital allocation and business managers should focus on operations.

Most importantly, Cohen’s dividend growth approach is designed to help investors, professional or novice, maintain their investments during down periods of the market cycle. As stock prices fall and interest rates are pared to stimulate economic growth, dividend-paying stocks will be buoyed, in a sea of sinking share prices, by investors searching for income.  Moreover, dividend growers are particularly beneficial, said Cohen, because, in tough times, consistent income growth from dividend-growing companies will compensate for stagnant wages. During periods of significant market turmoil, the less volatile nature of dividend growers will mitigate shareholders’ fight or flight response.  

Cohen’s dividend-growth approach also prepares a portfolio for future market volatility. Dividend payments act as a countervailing force to elevated asset valuations because, as market multiples expand, dividends grow a portfolio’s cash balance and reduce the relative amount of capital exposed to an extended market. During a market downturn, as cash in hand accumulates relative to the portion of the overall portfolio. By rebalancing to target weights of equities and cash, Cohen and like-minded investors systematically buy stocks at discount prices.

My Take

Do not be confused; past dividend growth does not ensure consistent future dividend growth; Cohen said he wants to own stocks that will be dividend aristocrats thirty years from now. Moreover, Berkshire Hathaway is one of Cohen’s largest positions, despite its policy to not pay a dividend, because he trusts Berkshire’s ability to allocate capital. The spirit of Cohen’s approach, not the letter, is important.

The most valuable lessons reinforced by this episode were related to dividend growers’ power of simplifying portfolio management and achieving better results for shareholders. Dividend growers stabilize portfolios through the nature of their share price stability and by simplifying the rebalancing process (by growing the portfolio’s cash balance). Though investors may lust for soaring prices of growth stocks, a more measured approach is much easier to maintain as market levels retreat. Cohen’s may be a less thrilling approach, but an individual’s ability to time the market is less important than his or her time invested in the market. Private investors tend significantly underperform the market (and even underperform the funds in which they invest) as they chase returns when buying at market peaks and clamoring for the exit as markets dive.

As Cohen recommends, investors should study history to prepare for the mental turmoil of market downturns. Investors should also consider the history of investor behavior during recessions and adopt an approach to avoid common mistakes. Two parlay, two paraphrased Warren Buffett quotes, temperament is more important than an investor’s intelligence because you have to maintain market positions through tumultuous periods for the market to find success as an investor. If you lack nerves of steel, you would be wise to mitigate the volatility of your portfolio because an ounce of prevention is worth a pound of cure.

Dorsey: This Man Actually Wrote the Book on Economic Moats - Invest Like the Best

Yesterday, I listened to a podcast episode of “Invest Like the Best” that featured host Patrick O'Shaughnessy speaking with Pat Dorsey, an asset manager and long-time director of equity research at Morningstar, about his approach to investments. Dorsey has written well-received books on the subject and below are my notes from the discussion. If investing in companies with significant competitive advantages interests you, I recommend listening to the conversation between Patrick and Pat.

Economic Moat

Dorsey is known for developing Morningstar’s moat rating system which he derived from Warren Buffett; Buffett first described GEICO’s competitive advantage as a moat around an economic castle in his 1986 letter to shareholders of Berkshire Hathaway. Dorsey expanded on Buffett’s idea by defining an economic moat to be a structural characteristic of a business that insulates it from competitive forces. Such an advantage allows a company to reinvest capital at favorable rates of return by preventing competitors from entering the market and depressing margins.

Four Types of Moats

1. Intangibles

• License

  • Must be enforceable

  • Subject to Regulatory Risk

• Brand

  • Prestige

    • Display Status

    • Identify Culture

• Identification    

  • Simplifies a customer’s search cost

  • Driven by Awareness and Advertising

  • Formerly controlled by Mass Media

  • Under pressure from reduced cost of exposure due to the internet and social media

• Trust

  • Build on reputation and past success

  • Social Proof

2. Switching Costs

• Captive Customers
• Plumbing/Infrastructure for specific/niche industries
• Abuse/neglect: products/services may suffer, without recourse for customers

3. Network Effects

• Returns to Scale: Customer/User experience improves with network growth
• Radial Vs. Interactive
  • Radial - Hub and Spoke Networks
    • No significant user benefit from larger networks
    • Competitors may supplant incumbent by strategically focusing on individual connections
    • Examples: Airlines, Western Union
  • Interactive Networks
    • Users benefit from interaction with others or the presence of other users
    • Loss of a single user or network connection does not significantly impair the overall network
    • Examples: Facebook, Mastercard

4. Cost Advantages

• Manufacturing Efficiencies
• Scale
  • Intangible Assets
  • Research and Development
  • Ability to Improve Products/Services
• Scope
  • Experience
  • Trade Secrets

The key to analyzing economic moats is to understand how a company can and will use its competitive advantage to deliver returns to shareholders. Not all moats are created equal. Some moats are more challenging to maintain, but, compared the alternatives, Dorsey prefers a business displaced only at significant cost to customers;  a moat derived from high switching costs is most easy to defend. A network business like Mastercard or Facebook may have to spend more to defend the competitive advantage, but the potential to reinvest capital at high rates is also very intriguing.

Every business is unique, and each moat must be analyzed individually. When O'Shaughnessy asked him how to use statistics to identify businesses with competitive advantages, Dorsey explained a statistical approach restricts the investor’s analysis to past performance; greater emphasis should be on a business’ potential to maintain and expand its moat. Coach used to be a brand synonymous with prestige, but, in pursuit of revenue growth, its management allowed the brand’s position to deteriorate. Mastercard did not appear to be an exceptional business at the time of its initial public offering, but through strategic analysis, and, of course, hindsight, Dorsey explained generating a marginal dollar of revenue is particularly inexpensive.

Capital Allocation

A business whose customers have prohibitive substitution costs may deliver considerable operating cash flow but lack opportunities for reinvestment; in this case, managers and investors face a different challenge. Without organic growth opportunities managers must be skilled capital allocators and strategically return capital to shareholders or make accretive acquisitions that bolster or complement the existing business.

Thoughtfulness, Dosey posited, is the most important characteristic for a capital allocator. Generic strategies that divide capital equally across share repurchases, dividends and acquisitions are most off-putting. An opportunistic approach to share repurchases is most admired. Companies that blindly employ WACC as the hurdle rate for new projects, especially with historically low interest rates, need higher standards.

Investment Process

Finally, Dorsey shared with O'Shaughnessy the process his firm uses to analyze prospective investments. First, Dorsey eliminates from consideration all businesses with poor economic structures. Then, with a considerably smaller universe of companies, a brief description of the prospect outlines the business’ moat and opportunities. Once a promising idea is in one or two paragraphs and approved for further investigation, a first-pass memo is written to formally characterize reinvestment opportunities, structural advantages, and management’s ability to allocate capital. Dorsey’s team then commits to much more thorough research, considering what they have learned about the company and providing many more opportunities to reject the potential investment. Dorsey’s portfolio is extremely concentrated, so it seems safe to assume his team will dismiss the vast majority of prospective investments.

As a business-focused investor, I enjoyed this conversation and learning about Dorsey’s approach. One of the most useful points Dorsey made was comparing moat analysis to analysis based on Porter’s Five Forces. Porter was a management consultant – he was paid to analyze businesses and their structure.  Investors, Dorsey explained, were not burdened to be so thorough: once a prospective investment is deemed unsuitable (for any particular reason), the investor should move on to the next prospect without further consideration.

Fish for A Lifetime: A Reminder to Focus on Your Investment Process

During this weekend’s long run, I was reminded of a few nuggets of wisdom for individual investors when listening to a few episodes of a podcast titled “Capital Allocators.” Host Ted Seides, CFA is an experienced institutional asset manager whose career has focused on investing in hedge funds as a “fund of funds” portfolio manager. Perhaps most famous for his unfortunate bet against Warren Buffett, Seides began the Capital Allocators podcast in 2017 to “introduce (listeners) to leaders in the money game and explore how these holders of the keys to the kingdom allocate their time and their capital.” Seides’ conversations with professional institutional managers offer access to valuable insight, and the podcast has a high priority in my rotation.

Episode 17 presented Seides’ discussion with Adam Blitz, CEO/CIO of Evanston Capital Management (a fund of funds manager), in which Blitz shared his firm’s investment process. Most interesting was Blitz’s description of how Evanston analyzes managers. When evaluating hedge funds for potential investment, Blitz prefers to focus on a prospect’s investment process, not its specific ideas.

Private investors should think like Blitz when managing their portfolio. Focus on your investment process and do not fixate on specific investments. By creating and refining a particular investing approach, an investor is more likely to find success by avoiding mistakes and overcoming cognitive biases. Think of the old fishing proverb: give someone a fish, and they eat today; teach someone to fish, and he/she will eat for a lifetime. Focus on developing and perfecting a sustainable investment process. Your process may or may not involve an investment advisor; your process may require fifteen hours per week or an hour each month. Develop and refine your approach to investing, and you will catch fish enough for your lifetime.

Follow this link to view more of my favorite podcasts and resources.

Why are ETFs so Cheap?

Exchange traded funds (ETFs) are low-cost investment vehicles that provide exposure to broad portfolios or specific assets. I recently found an informative resource that answered questions I have had about ETFs. This video from ETF.com explains how the structure of ETFs provides benefits over traditional mutual funds, but also the added risks of investing in ETFs.

ETFs often maintain lower expense ratios than comparable mutual funds – yes, even broad-based index funds like Vanguard’s S&P 500 Index Fund*.  But how can ETFs be competitive with index funds? And, while we’re thinking about the structure and processes of ETFs, how does an ETF grow in total value if its shares are traded on an exchange?

ETFs reduce the administrative costs of a fund by limiting interaction with shareholders. Instead of issuing shares to every individual who invests in their fund (individuals send money to mutual funds and mutual funds issue shares to individual investors), ETFs issue shares only to Authorized Participants that invest assets (such as blocks of shares in specific proportions) with the fund company. Authorized Participants are institutional investors that use market operations and the Creation/Redemption Mechanism to ensure the value ETF shares equal the value of their underlying assets.

Mutual Funds: Accept funds from and distributes shares to individual investors.

Exchange Traded Funds (ETFs): Only accepts blocks of assets from and distributes shares to Authorized Participants.

ETF shareholders benefit from lower fees because fund companies pass along cost savings related to lower administrative costs (ETFs do not need to transact with or maintain records for individual investors). Since Authorized Participants provide and redeem assets in kind, ETFs, unlike mutual funds, avoid realizing capital gains for continuing shareholders.

Unfortunate aspects of ETFs include standard trading costs for investors including bid-ask spreads and commissions on transactions. Mutual Funds, by contrast, may avoid commissions (when investors invest directly with the fund company) and always issue shares at Net Asset Value (NAV).

Simplified operations for fund companies plus low fees and diverse offerings for shareholders have incentivized the broad flow of funds into ETFs, but investors must be vigilant and fully understand any product in which they invest. ETF.com advises investment in highly liquid ETFs with narrow bid-ask spreads; to be aware of the impact of commissions; and avoid investing complicated leveraged products that are intended to be held for short periods.

I first learned of ETF.com from an interview of ETF.com’s CEO, Matt Hougan, by Consuelo Mack on Wealthtrack (an excellent educational source of investor information via interviews with influential investors).

*Technically, on the date I wrote this post, Vanguard.com reported the expense ratio for Admiral Shares of its S&P 500 index fund to equal the expense ratio (0.04%) for the comparable ETF. Investor shares can be obtained by an initial investment of $3,000 while the minimum required to obtain admiral shares is $10,000 – once your stake in any Vanguard fund crosses the minimum threshold to obtain Admiral Shares, Investor Shares may be converted to Admiral Shares.

Notes from the Berkshire Hathaway Q&A

Warren Buffett and Charlie Munger are living legends. Like many investors, I read every Berkshire letter to shareholders and tune into the company's annual meeting for the question and answer session. The following are my notes from the 2017 Q&A session that was held on Saturday. 

1.       Recognition of Jack Bogle

To begin each Berkshire Hathaway shareholder meeting, Warren Buffett introduces each member of Berkshire’s board of directors, but this year he also recognized Jack Bogle, the founder of The Vanguard Group, as the person who has done more for individual investors than any other financial professional.

2.       Focus on Great Businesses

Buffett and Munger said, after years of investing in businesses they considered undervalued but fixable, they have learned to invest in businesses that have superior economics and resistant to innovation. Attempts to fix unfixable businesses were horrible experiences and Buffett and Munger now avoid such bargain-priced companies.

3.       A Common Question

What would you do differently were your business a private corporation, is a question Buffett likes to ask public company executives.  Were Berkshire privately held, Buffett would make no change to its management.

4.       Rationality Over Brilliance

Munger said many business people and investors struggle in their aspiration to be brilliant. Instead of gambling in pursuit of brilliant results, Munger said he and Buffett wait for market conditions to present rational opportunities. People prefer action, will be drawn to gambling, and inevitably their mistakes will cause poor financial results and thereby provide opportunities for rational investors.

5.       Berkshire Hathaway’s Value Added to Society

One shareholder asked Buffett to explain what Berkshire contributes to society. GEICO provides low-cost car insurance. Dairy Queen provides products that make customers happy. Berkshire is a holding company that does not sell products, so what benefit would be forgone if Berkshire’s subsidiaries were independent?

a)      Focus. Berkshire’s structure allows several large holdings to avoid investor relations responsibilities and other tasks required of publically traded companies. Buffett said, under the Berkshire umbrella, managers from Berkshire Hathaway Energy (BHE), Burlington Northern (BNSF), GEICO, and Precision Cast Parts (among others) have twenty percent more time to allocate to business operations.

b)      Shelter from the Reactionary Behavior of Short-term Investors. As independent, publically-traded companies, Berkshire Hathaway subsidiaries may succumb to pressure to produce consistent short-term results, but the diverse portfolio of Berkshire’s subsidiaries obfuscates the short-term volatility in one constituent’s business results.

Buffett noted recent disclosures of GEICO’s competitors disclosed the pursuit of new policies were forgone due to the costs of initiation and the tendency of higher loss rates of new policies. By contrast, GEICO reported significant growth in new policies written, and Berkshire is well-positioned to benefit from higher-margin renewals in years to come.

c)       Capital Allocation. Berkshire is an ultra-low cost source of financing for its subsidiaries, and Buffett has displayed unmatched patience and rationality with shareholders’ capital. Berkshire subsidiaries like BNSF and BHE have been able to retain earnings to fund capital investment without scrutiny from public investors who require dividends and share repurchases. If additional funding is required for large projects or bolt-on acquisitions, Berkshire is flush with cash.

d)      An Example. Munger concisely explained he, Buffett, and Berkshire are model citizens of corporate America and examples for both investors and business executives. Widely regarded as an honest company, Berkshire is a model of corporate governance.

6.       Health Care Costs Impair the Competitiveness of American Businesses

While corporate income tax rates are in the news, corporate income tax remittances have fallen over recent years, but healthcare costs, often paid by employers, depress the relative productivity of American labor. In many other developed nations, health care is provided by governments, not employers. Further, comparable healthcare in the United States is more expensive than in other countries. Regardless of the relative difference in monetary wages, domestic labor is more expensive due employee healthcare costs.

7.       Buffett and Munger Hate EBITDA

To report favorable earnings companies may report earnings before interest, taxes, depreciation, and amortization (EBITDA). Buffett and Munger assailed the use of EBITDA because it excludes the very real cost of depreciation. Instead of recognizing the full cost of an asset in the period in which it is purchased, depreciation is used to expense the cost of capital investments across all periods in which the asset is in use. Thereby a firm can match the cost of an asset to the revenue generated during asset’s use. Excluding depreciation from analyses systematically understates the true cost of business operations.