Friday Five: Buffett Praises Index Funds, Defends Sequoia

Christine Benz: Hi, I’m Christine Benz for Morningstar.com and welcome the Friday Five. Joining me to provide insights on the top business and market news of the past week is Morningstar editor Jeremy Glaser.

Jeremy, thank you so much for being here.

Jeremy Glaser: You are welcome, Christine.

Benz: Jeremy, I’d like to talk about Berkshire Hathaway. The meeting was last weekend and I know that you and the team were out there covering the meeting, attending the meeting. Let’s talk about the key takeaways in your mind from the meeting.

Glaser: It was a great meeting and I think one of the important discussions actually was one that Buffett, was a question he almost he asked himself. He set some time out before the lunch break to talk about how being kind of a more passive investor, an index investor is really OK and that you shouldn’t necessarily always be trying to beat the market. He pointed out that on the whole active investors are going to have the market return, but it’s going to be less those higher expenses that means that they are going to underperform...maybe as a group they are going to underperform more passive index investors. So he definitely was making that case. But it’s funny because he also spent a lot of the meeting making the case for certain active managers and certain active strategies-- obviously he’s an example of someone who’s making active bets and has been very successful in doing that.

There was lot of discussion about the Sequoia Fund given some of the recent challenges they've had, and he expressed both confidence in the current management team and their ability to do well and also looking at the track record of Sequoia over time as being very strong. So some defensive active management there, too. I think this is an important lesson for investors here, that you really do need to think of those passive indexes as a really a benchmark. If you are going to make active choices, if you are going to pursue active management you should think of it as.... You should measure it against what would happen if you did have just kind of a passive blended portfolio and see how you are doing against that over time. I think he really brought that point home during the meeting.

Benz: I really like that idea; in fact, I often tell investors to create--on Morningstar.com--that blended all-ETF benchmark for themselves just to see how their active choices are faring. A question for you Jeremy, though, to follow up on the Sequoia discussion. I think investors maybe should know that Berkshire has had a longtime connection with Sequoia and let’s talk about that. And I guess a question is, is Buffett’s long history with Sequoia somewhat influencing his thoughts on whether the fund is worth hanging on to?

Glaser: I think it probably does, or certainly could. The reason it did come up during the meeting is because of that history; when Buffett wound down his partnership to take over the helm of Berkshire Hathaway, he kind of suggested investors go into Sequoia fund. That was where a lot of that money went. Sequoia was a major holder, a big concentrated holder of Berkshire for quite some time. So there definitely is lot of overlap, and they're fund that he's known well for years. So I think that probably does impact his thinking somewhat in discussing what’s happening at the fund.

Benz: The next news story I want to cover with you, Jeremy, is Priceline. Its CEO was pushed out; the shares really did not fare well this week. Let’s talk about what’s going on there.

Glaser: They had a couple, maybe a bit of a rocky couple of weeks here. So first the CEO was alleged to have an inappropriate relationship with an employee that was not in line with the code of conduct, and he left the company. And then this week they had earnings that were OK--the earnings themselves--but gave some guidance that really showed that there is a weakening of demand for travel. And Priceline has a lot of exposure to Europe, too; there is lot of questions about what’s happening with the European travel demand in particular. So that did send the shares down quite a bit this week. The CEO news was taken more in stride when it came out, but our Priceline analyst Dan Wasiolek really thinks that these are more short-term timing issues more than any sign that the true competitive advantage of Priceline has really been diminished in any way. He still sees the shares as looking at attractively priced. They are in 4-star territory. He thinks that investors with a longer-term time horizon can still find some value there.

Benz: The next item I want to discuss is auto sales. There had been some consternation that maybe the automakers were encountering some serious weakness. Let’s talk about your thoughts on that sector.

Glaser: Through the recovery autos have been really a bright spot, and there haven't been a ton of bright spots, particularly on the industrial side. And the numbers we saw in March were pretty weak, and fortunately in April we saw a bounceback there. I think that really confirms some of the thinking that maybe those March numbers were being impacted by the timing of the Easter holiday, by some weather-related issues, and that it wasn’t really a sign that demand has fallen off the cliff, and we saw that very much in those April numbers. Ford had a very strong month, their strongest in quite some time. And GM also had a good month. They saw sales decline a little bit, but that was because they are really trying to cut back on those low-margin fleet sales and focus on the more profitable vehicles. That’s a good sign for GM, even if that headline number is down a little bit. So definitely some good news on the auto sales this week.

Benz: Also within the auto sector but at the very high end, Tesla surprised the market a little bit, not so much with its earnings, but with its plans for production. Let’s talk about that.

Glaser: That’s right; earnings showed another loss. They continue to be in this heavy investment phase, but they really did seem to indicate that they are going to very aggressively expand production much more aggressively than the market had expected beforehand in order to get more Model 3s on the road, their new lower-priced vehicle. In order to really try to become more of a mass-market brand instead of this more niche electric car maker. And we’ll see exactly how they are going to be able to pull this off. It is going to take...it is a very ambitious schedule and it will take a lot of investment.

On that front, Dave Whiston who covers Tesla for us thinks that they are going to have to raise more capital, probably both equity and debt, in order to get the money that they need to build out these factories faster, to think about how to improve their production processes to get more of these cars on the road. So there really are reasons to be optimistic and also reasons to be pessimistic about the future of Tesla. On the optimistic side, they really have a very enviable brand. These are cars that people want. I think if you look at the preorders for Model 3, it's a sign that there is a lot of excitement built up around these cars and that people really do see them as a superior product. But on the other side, they still are operating in what’s a cyclical and very capital-intensive industry of auto manufacturing. That’s always going to be the case.

There is also going to be more competition in the electric car space. The other makers aren’t just kind of sitting still here; they are working on new products, and even if people still see Tesla as a good product it won’t be the only one that’s in the marketplace. So that could have an impact as well.

Benz: Another set of companies I’d like to get your take on, Jeremy, is the media sector. There had been some concern that this talk of cord-cutting, people getting rid of their cable providers, would put downward pressure on these media companies. How did that play out in terms of their earnings?

Glaser: You're right that this has been a major concern. But the earnings this quarter actually looked pretty good and we saw a rebound in a lot of earnings from companies. We heard from CBS, Time Warner, Twenty First Century Fox, Discovery Communications. All had strong quarters. And Neil Macker, who is our media analyst, really thinks that a lot of these fears are very much real. The cord-cutting is going to have an impact, the switch to these kind of more over-the-top services--it’s not going to necessarily be a smooth one. But that there still is value in the content that a lot of these firms still have economic moats. And because of some of these fears they are trading at pretty decent discounts to their fair value estimate. It’s not uniform--some look more attractive than others, but for investors who maybe have been considering the media space there still are some opportunities out there and that it might be something that’s worth some more research and some more investigation.

Benz: Sounds like a sector to watch. Jeremy, thank you so much for being here to provide your insights.

Glaser: You are welcome, Christine.

Benz: Thanks for watching. I’m Christine Benz for Morningstar.com.