“‘So Jeff, in your November Strategy Report you said, I recommend the gradual accumulation of stocks because they are trading at below known values. What are your top three stock picks?’ My response was Teledyne, Teledyne and Teledyne!”
… Jeffrey Saut, E.F. Hutton (11/20/1974)
The year was 1974 and Teledyne (TDY/$77.56/Outperform), on a split-adjusted basis, was trading at about $0.05 per share. By 1986 it was changing hands around $75 per share. Unfortunately, back in 1974 I didn’t have enough money to buy more than 10 shares, having lived through the devastating bear market of 1973 – 1974 where the D-J Industrial Average (INDU/15118.49) lost 47% of its value. At the time Warren Buffett was stating he felt like, “A kid in a candy store” because companies were selling at below net/net working capital and the INDU was changing hands at 6x earnings, below book value and with a dividend yield of 6%+. I was reminded of Teledyne last week by the excellent article written by Andrew Ross Sorkin co-anchor of CNBC’s Opening Bell. Andrew was a gifted writer for the New York Times before joining my friends at CNBC and regrettably he now writes more sparingly for the Times. However, his article in the Times last week, titled “For Buffet, the Past Isn’t Always Prologue,” was, by my pencil, the best article of the week!
For the record, Henry Singleton was the Warren Buffet of that era. Singleton was the co-founder of Teledyne in 1960 and built it into one of the most profitable companies ever. He was the pioneer of company share repurchases, as well as the instigator of the purchase of deeply undervalued companies. He had an uncanny ability to resist fads, as well as criticism. His focus was on 1) defining his investment framework by following a strict discipline; and, 2) always doing his own work. Those focuses generated extraordinary results from ordinary businesses whereby Teledyne enjoyed 30%+ returns on equity, and EPS growth of greater than 1200% in a 10-year period. Teledyne’s businesses were diverse, but with exceptional returns on capital that included companies like offshore drilling units, auto parts, machine tools, electronic components, engines, Water Pik, etc. Singleton often stated, “After we acquire a business, we reflect on all aspects of that business. Our conclusion was that the key was cash flow.” He went on to note that investors should NOT focus on accounting profits, but free cash flow that can be redeployed in the business at a high rate of return to shareholders.
Moreover, like Buffett, Singleton concentrated his investments with Litton, at one point making up 25% of his investment portfolio. He also tried to stay within his “circle of competence” by buying companies that paralleled Teledyne’s strengths. Further, Singleton liked to buy companies at 6x earnings (price/earnings), with an earnings yield of 17% (earnings/price), because such metrics provide a large margin of safety on the downside. After spending decades creating one of the world’s largest conglomerates, Singleton stepped down as CEO in 1986, but remained as Chairman, and decided to break the company into three pieces, believing it had become too big for a single manager to oversee.
I revisit the Henry Singleton’s Teledyne story this morning because my friend Doug Kass, of Seabreeze Partners fame, peppered Warren Buffet with questions at last week’s Berkshire Hathaway annual event in Omaha. One of his more prickly questions was, “Should Berkshire be broken up into various pieces, like Henry Singleton did with Teledyne, to maximize shareholder value?” After a long pause a scowling Warren Buffet responded, “Breaking them up into several companies I’m convinced would create a poorer result.” Charlie Munger, Buffet’s partner, added, “I don’t think you should get into your head, just because he is a genius, [that] he did it better than us.”
I read Sorkin’s article a few times and got the sense that Warren Buffet, and Charlie Munger, have been merely copying the traits of Henry Singleton’s investment style. I also have to question, after the transition to new leadership, if Berkshire can compound money as well as it has under the current dynamic duo? For example, it is doubtful that new management will be able to command the kind of special convertible preferreds, with very high dividend yields, that Buffet was able to garner from companies like Goldman Sachs and General Electric among others, which have clearly helped Berkshire’s performance.
Dougie concluded by asking Buffet if his son Howard would be installed as the nonexecutive chairman of Berkshire by asking, “How, beyond the accident of birth, is your son qualified to be nonexecutive chairman?” Buffet responded, “He has no illusions at all of running the business.” Charlie Munger chimed in with, “I want to say to the many Mungers in the audience: Don’t be stupid and sell these shares.” And, last week that advice proved correct as Berkshire shares traded to new all-time highs.
Similarly, the equity markets traded to new all-time highs last week led by the strongest sectors – Industrials (+2.28%), Consumer Services (+1.88%), and Basic Materials (+1.88%). Interestingly, there was a rotation out of the defensive sectors as seen in the large 2.42% decline of the Utilities. I have previously warned that the Utilities, and Consumer Goods, sectors were about as expensively valued as they ever get and advised trimming back on those positions in favor of the other eight macro sectors. The Utilities have also come under pressure the past few weeks as interest rates have spiked, with the 30-year Treasury bond’s yield rising from 2.81% to 3.13% in just seven sessions. That move also caused the T’bond to travel above its 50-day moving average (DMA), which gives a negative look to its chart pattern (see chart on page 3). Moreover, the long bond is now up from what I have termed the “yield yelp” low of 2.45% last July for a total rate-ratchet of roughly 28%. Buoyed by higher interest rates, the U.S. Dollar Index has likewise climbed above its 50-DMA (read: bullishly). While the strength in the greenback has surprised me, it does give foreign investors a “double kick” when combined with a rising U.S. stock market. The reciprocal, going back to last October, would be Japan’s Nikkei 225 Index, which is up 71% when measured in yen, but is up by 32% when measured in U.S. dollars. Speaking to the waning earnings season, as of Friday 57.6% of reporting companies have beaten their earnings estimates with 51.6% beating revenue estimates. Accordingly, so much for the negative nabobs that have told us for seven quarters that earnings were going to fall out of bed. This week the economic calendar is much more robust than last week with the more import reports of Retail Sales (-0.3e), Industrial Production (-0.1e), Capacity Utilization (78.3e), Housing Starts (980e), Philly Fed (2.5e), and Leading Indicators (0.2e) on tap.
The call for this week : As stated in Friday’s verbal strategy comments, there is a small window for a mild pullback this week with my daily internal energy indicator out of energy. However, there is minor support for the S&P 500 (SPX/1633.70) at 1614, and major support between 1590 and 1600, so I think any selling should be contained by one of those support levels with no damage to the uptrend. More importantly, last week the Buying Power Index crossed above the Selling Pressure Index (see chart on page 3), confirming the strength of the primary uptrend. Accordingly, I don’t think the bears can prevent a move to 1700 into the end of the quarter (July 1st) unless there is some kind of “black swan” event.
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© Raymond James
