USG Corp: Another Buffett 'Failure to Sell' Mistake 39 comments
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USG Corporation (USG) [the old US Gypsum] has been hit hard by the housing downturn. EPS fell from a cyclical peak of $11.01 in 2005 when the boom was still in place to just $1.04 in 2007. Current estimates are widely varied but the consensus view is for a loss this year of ($1.30 - $1.40) and perhaps another losing year of ($0.26 - $0.49) in 2009.
As of March 31, 2008 Berkshire Hathaway held over 17 million shares or about 19% of the shares. While few people predicted the ferocity of the housing decline well in advance the signs of a stock price that was too high back in 2005 – 2006 were clear to those who paid attention to historical valuation parameters for USG shares.
As with most cyclical stocks, USG traded at relatively low P/Es when earnings were strong and higher absolute multiples when earnings were punk.
Here is a chart showing the historical data on USG from 2000 onward.
Year……..High Price …Low Price……..EPS ………Avg. P/E
2000 ………$46.90 …….$13.10…….…$6.48 ………. 4.8x
2001 ………$24.80 …….$2.80 …….....$1.01 ….……. 9.7x
2002 …….…$9.10 ..…... $3.30 ………..$3.22 ………. 1.9x
2003 ………$23.70 …….$3.80 ………..$3.19 ………. 3.8x
2004 ……... $41.70 …….$12.30 ………$7.26 ………. 2.8x
2005 ……... $71.30 …….$26.80 ……...$11.01 ……… 4.4x
2006 …….. $121.70 ….. $43.70 ……... $6.53 ………. 10.6x
2007 …….. $58.70 ……..$34.70 ……… $1.04 ……... 42.8x
Investors who bought USG shares in early 2006 when trailing earnings were over $11 might have thought they were getting a good bargain on a growth stock at just 11x previous year's EPS. However, that eleven multiple was higher than USG had ever commanded when earnings were good. USG typically sold for 3 – 7 times EPS in boom times for builders.
The one brilliant move that USG management did was to give its shareholders a rights offering to buy newly issued shares at $40 on
July 27, 2006. By giving out rights to buy new shares at the then below market price of $40 they ensured virtually 100% subscription to the offer.
At year-end 2005 the book value of USG was negative at (-$6.77/share) and there were 44.64 million shares outstanding. By year-end 2007 USG's book value had been pumped up to a positive $22.14/share through the anti-dilutive rights offering. As of December 31, 2007, there were 99.05 million shares outstanding.
Investor who took the new shares and sold shortly thereafter did well. Those who exercised their rights but held on have suffered losses. USG shares closed at $34.18 yesterday, May 23, 2008.
Anyone who has held these shares since their peak in March 2006 has seen their market value plunge by 71.9% over the past 26 months. While the housing market will eventually recover USG shares have no dividend yield and no prospects for positive earnings anytime soon.
What's the lesson to be learned here? Cyclical shares need to be sold when everything looks rosy and only likely to get better. It's hard to investors to exit these stocks at the top because all the headlines are positive and the macro-environment couldn't look better.
That's why keeping an eye on valuation metrics for your holdings versus historical norms for the same companies are so critical.
Warren Buffet and Berkshire Hathaway shareholders certainly would have been better off today had he sold these shares 2 – 3 years ago instead of following his "My favorite holding period is forever" policy.
Disclosure: No position in USG.
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This article has 39 comments:
Bought with Euros that make dollar denominated assets extremely cheap right now.
It might make sense on that basis over a multi-year time horizon.
You're dead wrong (financially speaking). You have to write for a living because you aren't a superior investor.
His approach is best. Buy and hold onto excellent companies. Try to time the market and you'll lose (which is why you're still writing).
It blows my mind that so many mock Buffett, except when I realize that jealosy always abounds around the masters of anything.
Also, those who "exercised their rights" to their options, haven't lost anything. Haven't you realized yet that until you sell, no story can be told?
If anyone but Buffett had that result they'd be blasted.
I suppose you might have something to write about as it pertains to Coke, American Express, Well Fargo, Budweiser, Wal-Mart and other business he has make millions by buying when "there is blood in the streets".
His record at 'overstaying' in stocks like KO, Moodys, and others is his weakness.
KO was almost $90 /share in 1998 and is still well under that 9 years later. It was down by more than 50% from its high not too long after the peak.
USG is down over 70% from its 2006 high. Clearly any rational person would say he would have been better off selling back then even if he wanted to come back in to buy USG shares again later at much lower prices.
Realistically he's down about 30%. He bought most of his shares around $50, and now they're down to $34. But I really don't think he's worried about it. Who cares if the shares are down right now? With Buffet's help, this stock will be back up to $60-$70 within the next couple of years. He's a long term investor, and in the long term, he's going to make an enormous profit on this investement. Just like he always does.
Any holder at the peak could have sold and avoided a 70% drop from that point forward.
When the housing downturn is over if USG pays a dividend of less than 5 % and the price to tangible book ratio is over 2...I will not buy the stock.
Thanks for writing this article.
Listen, before you write anything read at least the history of the company instead of doing a table of earnings and P/E ratios based on a 8 year history.
And sentences like: "The one brilliant move that USG management did was to give its shareholders a rights offering to buy newly issued shares at $40 on July 27, 2006." Yeah right.
Management only had to sort out the asbestos claims, modernize the plants, restructure the business in the process so they could lower the production costs for the future outlook. But hey! The one brilliant thing is that they issued shares at 40 bucks!
What a genius you are. This management is fabulous if you only understand the nature of low cost production in this housing downturn. They continued the vertical integration of the business and that will give a competitive advantage for years.
No wonder Buffett bought it and will continue to do so. I don't own USG but I am looking at it.
When judging Warren's investment decision at least try to understand that a year or two years or 5 years for a man who says that the ideal is to own a stock forever... really means nothing to him if the stock dips.
I guess its easy to look at the stock and see Buffett owning it and then rant about how bad his timing was... instead of understanding the business. But hey! That's why there's value in the first place!
If you think keeping a stock that dropped over 70% over a two year period was a wise move-then I wonder what you might classify as an investment decision mistake.
But the main point you don't seem to get is that he buys only great companies and USG is one of them. It has excellent management, it is a low cost producer, it has a moat and a brand (Sheetrock) and it is a growth story, when the housing market turns.
Berkshire got 17% of the company at 45$. So what if the stock falls to 25 or 15? Would that be a devastating loss? FOR GODS SAKE! It is a 3,5 billion market cap company and Buffett has 50+ billion of cash! He will buy the rest of the company (83%) at a lower price... so there is no loss for him.
Instead of focusing on the reasons why (the prospects of the company) Buffett did what he did, you just had to show the whole investment community what a superior investing mind you have... so instead of manufacturing some real ammo (facts) against his decision, you went on an elephant hunt with rubber bullets (your faulty perspective, logic).
From your article it is obvious you didn't read anything about this company, not even the transcripts. That's why you don't understand why Buffett bought this company in the first place.
You pissed me off, because if you at least wanted to sound scientific and provide us with a table of earnings for USG from 2000-2007, you could at least explain the stratospheric 11$ earnings in 2005 in a footnote below the table.
Where did that 11$ earnings come from and where did they go my friend? Do you know? No, you don't, because you didn't take the time to do the things properly.
You wrote a bad, obviously flawed article, because all you wanted to see was your inflating ego... instead of looking at Buffett's investment in USG from his perspective.
His investment in USG is a win/win situation.
So, going back to 2006/early 2007... how many people knew that a housing crisis was coming? Of course, right now, everyone says that they knew it was coming. But they're all lying: no one was saying this back in 2006. So, can you show me a link to an article that you wrote in 2006 saying that a housing crisis was imminent? If not, I really don't care what you have to say about USG right now, because it's all after-the-fact.
How about we assume Warren is somewhat rational (I don't think this is too far a stretch) and work backwards from there. At what valuation point would he have sold USG when it got as high as it did? If he thought it was worth $80 per share (meaning it would continue to return pretty good returns to investors at that price going forward), for example, would he have sold it at $120? I don't think he would. Given the taxes he would have had to pay and the uncertainty of being able to reenter the stock at an equivalent after-tax price, there is a strong argument to be made that he would simply hold on. If he originally bought at $50 he would have to pay tax on $70 of appreciation and that might be almost $30 per share right there.
Perhaps if he thought the company was worth $60 he may have sold, but he would not have invested at the prices that he did originally if he really thought it only worth that much as that would not give him all that much margin of safety.
I find your analysis to be quite shallow and unconvincing. It seems to me that your basic argument is that since the price now is well below the stock's recent high price that not selling it was stupid. But, of course, value investors believe that stocks often trade for significantly less than their fair value - so this movement in price would not be a shock to anyone who thinks this way.
If USG moves back up to $150 in 3 years, who would be right then?
What is this company worth?
No earnings, the only book value came from the rights offering, no yield. It's not an easy one to judge.
I see much better and more predictable stocks out there than USG.
How do YOU come to a 'fair value' for this stock? What is it and how would you justify it?
ps,,, while back some bizrag was pushing buffetts bank savvy with his investment of FNVG (from $5ish best i can tell,, now trading at $0.025-----------lol,, which is prolly actually his best investment going forward, i'll tell you why:
another bank can clean up their act and get new branding by simply paying off the bk debt $1b+ (and NO more skeletons in the closet like we have now in the current banking sector)
motleyfool and the media are constantly pumping warren buffett,,, (1st clue something smells) yet they never note all his debt his shareholders have to hold while he gets richer (paper richer) the magic math can only work for so long,, before the real math comes into play.
our family does its part to boycott anything warren buffett /socialism owned.........he has bet against america while trying to create a socialized america.........americ... was based on people looking to succeed that they couldnt do in another country not become europe and have a govt be their parent with constant applications of powder and lotion then eventually diapers on the people.
all we wait on now is for people to reclaim their 'americanism' and drop the 2nd+3rd world status in their country of preference.
Buffett's positions are often so large he can only sell when the stock is in a parabolic upmove, as he did with PTR. If he waits until other larges holders are in distribution mode (after April 2006 in this case), he will destroy the stock.
Your argument makes more sense if you frame it that he should have sold from January to April 2006 (hindsight is always 20/20), when the stock was in its parabolic uptrend and traded roughly between $70 and $120. Just eyeballing the volume that traded then, I'd estimate it traded about 1 million shares per day. Even when a stock is in a parabolic uptrend, anyone who tries to trade more than 10% of the daily volume will move the market. So Buffett could only have traded about 100,000 shares per day without putting pressure on the stock price.
100,000 shares per day*22 trading days per month*4 months means Buffett could have only sold about 8.8 million shares at prices between $70 and 120 from Janaury to April 2006. After the peak, the stock dropped from $120 to $60 in about 2 months. If he had been a seller of even 10% of the daily volume then, he would have absolutely destroyed the stock.
You can do this over a period of time and end up unloading huge quantities of stock at higher than market prices from the day you're writing them.
You just sell them and let the shares get called away. No muss, no fuss and no need to telegraph what you're doing.
Good luck finding a buyer for 170,000 calls. I'm not going to count the open interest for all contracts, but just eyeballing it I'd estimate the open interest for all strikes going out to January 2010 is about 12,000 contracts. And you think Buffett could find a buyer for 170,000 contracts?
The only buyers would be a gunslinging hedge fund or an I-bank prop desk, both of whom would only do the trade if they could not only screw you on the premium paid but also hedge their exposure.
I've already shown it would take about 8 months to sell 17,000,000 shares (i.e, hedge 170,000 options). Nobody is going to buy 170,000 calls from Buffett because the trade can't be hedged.
You would need to do this over a period of time but it can surely be done using multiple strike prices and multiple expiration months from near term to LEAPS.
If owning a major position was really a "roach motel" then neither Buffett nor anyone else would ever take that big a stake in anything.
Warren Buffet is human and a very good investor. If I had funds to re-allocate to USG at present, I certainly would. Nuff said.
You asked me how I would value USG and my answer is, "I don't know." Then again, I didn't write the article so I would not be expected to know... You wrote the article and your thesis is that because the stock was higher at some point he should have sold it.
Hmmmm. Does it follow logically that just because a stock is trading far from its high price that not selling it was a mistake given the information one had at the time? Of course not! 20/20 hindsight is a wonderful thing to have.
Regarding those that criticize Buffett's record - it is pretty funny. It's only one of the best of all time. He is not perfect for sure but come on and give him his due. I wonder what it takes to get a compliment out of you folks...
USG shares declined over 70% from there in a two year period. The company is now losing big money wiht no turnaround in sight.
If that is not a clear cut 'failure to sell' error what woould one of those look like?
Another thing, choosing company to invest in is not simply looking at their valuations etc. Financials will be the first one you look at, thats for sure. But as an analyst, you try to look at other things. You talk to the management as often as you can, to get a feel of how good they are. You go to trade show, you talk to competitors, talk to industry expert, you do channel checks etc. There are a lot of works involved.
Again, its easy to criticize this investment, but you do have to look at the overall performance. No fund manager will make a killing on every single investment. Each manager has their own investment style that they are comfortable with and they should stick with it....
Trying to time the market peak is a fools game. Of course it is easier to say when you already know what is the peak and what is the price now
Just my 2 cents worth
USG shares got as low as $23.12 and are now in the $26.50 range.
The failure to sell at $130 is even more clearly defined now.