Bruce Greenwald: From Graham to Buffett and on to Modern Value Investing

“It is not the strongest or the most intelligent who will survive but those who can best manage change.” —Leon C. Megginson

The Past, Present, and Future of Value Investing

There’s a new video out, as part of the celebration of Columbia Business School’s storied history over the past 100 year, in which Professors Bruce Greenwald and Tano Santos sits down and discusses a few different topics related to value investing.

Click image below to watch and listen to the interview.

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Bruce Greenwald on Warren Buffett’s Approach to Industry and Business Analysis

Below is a transcript of a part of the interview where Bruce Greenwald discusses a few different industries and businesses that Warren Buffett successfully has invested in, and why these industries may have caught Buffett’s interest. Transcript is from 28:05 — 33:57 (emphasis added).

Tano Santos: But what I mean with evolution is something different. I want to understand a little bit, you know, a want to think… if I think about Warren Buffett’s career, and if I think about the distinct phases he’s gone through, you know the traditional Graham & Dodd, his practice of franchise, his recent partnership with 3G, and…

Bruce Greenwald: So let me talk about that. If you’re talking about the intellectual evolution

Tano Santos: Exactly, that’s what I’m talking about.

Bruce Greenwald: We’ve done the exact right thing. We’ve watched what’s successful practitioners have done, and we’ve shamelessly appropriated them. And basically, what I think Graham didn’t understand, although he had inklings of it was that you could make money without assets if you were in an economic position that kept out the competition. That if you were in, what in Warren Buffett’s language is now called a franchise business, and the next evolution is that, I think mostly Warren Buffett, but I think there are others who understand this fairly early on in the 60s and 70s too, begin to understand that these economic forces will create hugely valuable businesses, and valuable businesses in a sense that the old Ben Graham businesses were not. So to grow profits in the old Ben Graham world you had to invest. And in the face of competition you were likely to earn what you had to pay the investor. So the growth didn’t add value. I mean you had to raise money at 10 percent, and there were lots of people willing to invest at 10 percent, and there where no protected economic positions competition was gonna drive the return to 10 percent. So you make 10 percent and you pay 10 percent, there’s no value in growth. And that’s why Benjamin Graham was never particularly interested in growth companies. He talks a little about how R&D can create pattern protected industries. But there is a sense that he had that it’s rare, and the cost of finding those technologies may be just another form of assets.

What Buffett does is he looks very carefully at these industries that’s interestingly enough. He does it in industries that he knows a lot about. And the first one I think, going back, are industries around Omaha. So he right away understands things like Nebraska Furniture Mart, and dominate the Omaha furniture market. And it it’s got 70 percent of the business, it’s got distribution economies, advertising economies that are gonna be very hard for a competitor to replicate. And Omaha is sort of an isolated city. And he understood that the force of that dominant market position meant first of all that they we’re gonna have in the end, cost advantages due to economies of scale and that they could exploit… and pricing power cause they could keep other people out. And as the market grew they we’re gonna get that market without having, because they had the economies of scale, additional investment. He clearly understands that about newspapers. Local newspapers have a hugely expensive distribution, advertising sales and reporting infrastructure. If you are established as a local paper and everybody is renewing their subscription, then nobody is gonna be able to enter that market. And again, you’re gonna be able to charge for it and have the economies in distribution and you get the growth. And then he understood, I think, in banking… there are famous instances in banking. The one was, for years, tobacco lending in actually Virginia and North Carolina and the rest of the back of the south was dominated by Wachovia Bank, and they knew all about the growers, and they knew all about the warehouse processes, they knew everything. And that meant they knew about good risk and bad risk. And I think a foreign bank decided these were the most profitable loans out there and they we’re gonna go in and enter that market. And what they did was of course they went to the Wachovia customers and they offered them lower loan rates. If that lower loan rate was profitable, Wachovia knew it and they would match it and they kept all the good risks. And if it was a marginal credit that wasn’t, Wachovia would call ’em in and say “God, we really like to keep you but that’s such a good offer. We suggest you go to this European bank.” And the European bank wound up with a 90 percent default rate. And in addition there were all the economies of scale in information collection in news. And really all economies of running local branches, which are like local economies. So he seems to have understood that. And then with Coca-Cola where there are huge economies in distribution. And in all these cases you could protect your market share cause there’s a lot of customer captivity. So he started to develop an idea of what these franchise businesses looked like. And I think also how you go ahead and value them, cause now assets are irrelevant and you have to think about other things, and growth matters a lot. And I think it’s that evolution that really starts to get you into modern value investing.

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Swedish Banking: Industry Map (part 1)

Industry Map

Industry map below based on figure 3 Illustration of banks’ various sources of funding and the risk of contagion effects, see page 83 here. Click on image to increase size.

BS22Structure of the Swedish Banking Industry

Number of banks

There are four main categories of banks on the Swedish market: Swedish commercial banks, foreign banks, savings banks and co-operative banks. In December 2012, Sweden had a total of 117 banks. The number of commercial banks and foreign bank branches in Sweden has increased from 42 in 2000 to 66 in 2012. The increase is due to the fact that, among other things, more foreign banks have been established in Sweden. In addition, the number of Swedish commercial banks have increased, including new Internet- and telephone banks as well as securities firms and credit market companies that has become banks.

BS19Swedish commercial banks

Swedish commercial banks are divided in three categories. The largest are the four big banks: Swedbank, Handelsbanken, Nordea and SEB. These banks are important players on most segments of the financial market. The second category is savings banks that have been converted into joint stock companies, often with Swedbank as a shareholder. The third category constitutes other Swedish commercial banks with a diverse business focus and ownership structure. Most of the other commercial banks were formed during the mid-1990s and ahead. At first these banks were mainly focused on the retail banking market and distributed their products and services online, but also through e.g. retail stores. In recent years several new banks have a background in securities trading and financing business. The new established banks have in course of time increased the selection of financial products and many of these banks are today regarded as universal banks.

Foreign banks

The first foreign bank was established in 1986, when foreign banks were first allowed to open subsidiaries. During a few years, in connection with the financial crisis in the beginning of the 1990s, the number of foreign banks declined. Foreign banks were permitted to open branches in 1990 and, since then, they have increased. In December 2012, they amounted to 29. Most foreign banks focus on the corporate banking and securities market. The largest foreign bank is Danske Bank which at the same time is the fifth largest bank in Sweden.

Savings banks

There are numerous independent savings banks in Sweden. Generally, they are small and active in regional or local markets. Most savings banks operate in co-operation with Swedbank as regards technical solutions and the provision of a common range of products and services. The number of savings banks has declined due to small savings banks having merged.

Co-operative banks

A co-operative bank is an economic association that has as its purpose to produce bank services for its members. To be able to use the bank services of a co-operative bank the customer must become a member by paying a member share. There are two small co-operative banks in Sweden.” (Source: Banks in Sweden)

The major banking groups
“Swedish banking groups

From the mid-1990s, Sweden’s leading banks have evolved into financial groups with extensive international activities. This development is partly due to areas such as life insurance, fund management and mortgage lending becoming an increasingly important part of the groups’ business activities alongside traditional banking. It has also involved geographical expansion by the groups, especially within the Nordic and Baltic regions.

BS20Nordea is the largest financial company in the Nordic region with around 33,000 employees. The group includes leading banks in Sweden, Finland, Denmark and Norway. Nordea’s lending consists of 75 per cent of lending from countries outside Sweden. The Bank’s Swedish operations include one of the largest finance companies and major players in fund management and mortgage credits. Nordea also owns the credit transfer payment system Plusgirot.

SEB is the name of the financial group formed around Skandinaviska Enskilda Banken. SEB has developed extensive international activities among others in the Baltic region and Germany. In Sweden, SEB has a strong position in fund management and life insurance, as well as in the mortgage and finance company sectors. SEB is also a strong player on the stock market and in currency trading as well as international payments.

Svenska Handelsbanken (SHB) has more than 460 branch offices in Sweden. From the 1990s the bank has also expanded in the Nordic region, both through acquisitions and by opening branch offices. The wholly owned mortgage institution Stadshypotek belongs to the largest players on the Swedish mortgage credit market. Handelsbanken also has extensive operations in the fund management and finance company sectors.

Swedbank has an extensive network of around 320 bank branch offices in Sweden. In addition, Swedbank is in close co-operation with the independent savings banks and partly owned banks among the savings banks movement. Swedbank also has major activities in the Baltic region. The group includes Swedbank Robur, Sweden’s largest fund management company, and Swedbank Hypotek, which is one of the largest mortgage finance institutions.

BS21Other Nordic financial groups

Other Nordic financial groups with a strong position in Sweden are Danske Bank, Länsförsäkringar and Skandia. Danske Bank is Denmark’s largest bank and has banking operations in all the Nordic countries. Danske Bank is, after Nordea, the largest financial group in the Nordic region. Länsförsäkringar consists of 23 regional insurance companies in co-operation, and together they own Länsförsäkringar Bank. Skandia is the market leader in life insurance but also has a strong position in mutual fund investments. SkandiaBanken is owned by the insurance company Skandia.” (Source: Banks in Sweden)

Operations of the Major Banking Groups in Sweden

OMBIS2013(Source: The Swedish Financial Market)

Bank Assets

To get some grasp of how big the different banks are, see image below.

BS5BS6BS14BS15BS16(Source: The Swedish Financial Market)

Geographical breakdown

BS4BS13(Source: The Swedish Financial Market)

Average Deposit and Lending Rates

BS12(Source: The Swedish Financial Market)

Bank Liabilities

BS18BS7BS17(Source: The Swedish Financial Market)

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.