Value Investing Meeting Notes (by Martha Werman) October 29, 2008 at MIT’s Stata Center 14 people attended, led by Raimondas Lencevicius and Austin Sher. Austin presented Gannett Co., Inc. (GCI). Warren Buffet bought part of this company in 1994. Our goal was to examine Buffet’s decision by looking at the company through 1994 only. Note that we purposefully did not look at the stock price, either in the years before or after his purchase. Since we knew it was an ultimately successful purchase, the goal was to determine how much we were willing to pay for it and how much we expected it to increase in intrinsic value over the next few years. Austin posed questions to the group which he wanted us to answer, and in trying to answer, to put ourselves in Warren Buffet’s shoes asking why we would want to buy or not buy Gannett in 1994. Reminding us that the aim of the group is to learn via exchange of ideas, Austin gave us a history of Gannett and we worked our way towards understanding what made it so attractive for Buffet in 1994 when he invested in it. What was the edge it had that would enable it to continue its growth? Q#1: Where does the money come from and how do they spend/invest it? In 1993 Gannett was a holding company for a variety of newspaper brands, a large newspaper chain of long standing, 65% of the income was from advertisers, and the rest from subscriptions and retail. Gannett owned billboards, radio stations, and newspapers. The company began publishing USA TODAY in the early 1980’s and it took 10 years for it to breakeven (begin making a profit). The representative blue color was the first use of color on a front page and made it distinctive. Other newspapers had to follow. Frank Gannett had a reputation for being ahead of the competition and he was one of the first publishers to provide a private jet for his reporters (to quickly transport them to where news was happening). He also co-invented the tele-typesetter. This 1920-30’s invention rapidly printed lines. Q#2: Buffet holds a company for at least 2 years, so what does he look for? He looks for a moat = a margin of safety. Gannett qualified because competition would have a high cost in entering the market due to high capital investment barriers to entry (i.e., complex machinery and the time it would take to breakeven). Austin read from Berkshire Hathaway's 1984 annual shareholder letter. The passage explained how "the economics of a dominant newspaper are excellent, among the very best in the business world". These letters are freely available from www.berkshirehathaway.com . Though newspapers' economics are not as attractive today (2008), the goal of the presentation was to make the lessons transferable - to learn how Buffet identified an A+ franchise with an A+ future at an A+ price. Other desirable qualities to a company are: - Patents it holds - Brand name recognition which makes customers more willing to buy at higher prices (ie, the seller has pricing power). Buffet waited for USA TODAY to become profitable before he bought. Otherwise he would be using his own equity to pay for the newspaper's losses. Looking at Gannett’s financial statements (balance sheet, cash flow statement, and income statement) for the years 1992 and 1993, we reviewed the assets, the operating and capital expenses/investments, the liabilities, examined to see if the debt was being paid off, and the shareholder equity. Further, it was explained that many assets are in reality liabilities. Definitions (note: Investopedia.com and Wikipedia.org are high quality sources for business definitions and explanations) : Operating expenses: These are expenditures where the benefit will be received within one year. Capital expenses: Investments in assets that are beneficial over more than one year. Instead of being expensed at the time you buy them, they are depreciated over the years that they are expected to be beneficial to you. Goodwill: if you buy a business, goodwill is the price you pay above the book value. Debt: long term debt should be reduced regularly annually; this is very important. Retained earnings = the sum of what was earned. Gannett’s cash flow, net income, gross margins (gross margin divided by sales), and profit margins (net income divided by sales) were steadily growing for the last ten years. Raimondas reviewed the format of a cash flow statement. operating income investment in property and machinery financing – taking on or paying off debt You want to see that they are able to pay off debt from their operating cash flow (= the cash flow from selling their main products). Raimondas formula from his IBD talk in September: Earnings in 10 Years: Ex. NKE has an avg ROE of 20% 10 yrs of ROE = Equity (1+ROE)9 =$8B Mkt cap $8B x P/E (15) = $121B ~ ROR = 13% after tax He divides the income by the equity, assuming it as a constant... He calculates the income in 10 Years: 10 yr x 15 = capital in 10-15 yrs. Calculate the ROR backwards from here. Your equity grows as your income does. The formula is found in the meeting notes from 9/24/08. Recommended: to take a financial accounting class.