In Warren Buffett’s 2006 annual letter to Berkshire Hathaway shareholders, released today, he comments on two different struggling industries. One, he believes, will once again see great days. The other, is doomed to growing irrelevance and shrinking profitability.
Though Buffett was rumored to be a buyer of newspapers, perhaps by desperate sellers who hoped he might be, he makes clear that he sees a grim future for the industry. Buffett writes:
Not all of our businesses are destined to increase profits. When an industry’s underlying
economics are crumbling, talented management may slow the rate of decline. Eventually, though,
eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago,
“If you want to get a reputation as a good businessman, be sure to get into a good business.”) And
fundamentals are definitely eroding in the newspaper industry, a trend that has caused the profits
of our Buffalo News to decline. The skid will almost certainly continue.
Buffett describes the factors that served to make newspapers huge cash cows for many years and describes the irreversible changes that are rocking the industry:
Now, however, almost all newspaper owners realize that they are constantly losing ground in the
battle for eyeballs. Simply put, if cable and satellite broadcasting, as well as the internet, had
come along first, newspapers as we know them probably would never have existed.
Finally, he suggests who the likely buyers for newspapers are:
For a local resident, ownership of a city’s paper, like ownership of a sports team, still produces
instant prominence. With it typically comes power and influence. These are ruboffs that appeal to
many people with money. Beyond that, civic-minded, wealthy individuals may feel that local
ownership will serve their community well. That’s why Peter Kiewit bought the Omaha paper
more than 40 years ago.
We are likely therefore to see non-economic individual buyers of newspapers emerge, just as we
have seen such buyers acquire major sports franchises. Aspiring press lords should be careful,
however: There’s no rule that says a newspaper’s revenues can’t fall below its expenses and that
losses can’t mushroom. Fixed costs are high in the newspaper business, and that’s bad news when
unit volume heads south. As the importance of newspapers diminishes, moreover, the “psychic”
value of possessing one will wane, whereas owning a sports franchise will likely retain its cachet.
Newspapers, Buffett believes, are to be reduced to mere trophies, symbols of the great wealth of their owners. But like the great works of Ozymandias, in time, nothing will be left but remnants of shattered printing presses.
Later in the letter, Buffett speaks about HomeServices of America, the second largest real estate broker in the U.S. With the weakening of the U.S. real estate market, HomeServices’ revenue and earnings dropped 9% and 50%, respectively, despite having made several acquisitions. Despite these negative trends, he remains optimistic:
Nevertheless, we will be seeking to purchase additional brokerage operations. A decade from now, HomeServices will almost certainly be much larger.
The difference between the newspaper industry and the real estate brokerage industry is a lesson at the core of value investing. Newspapers represent a dreaded value trap- cheap this year, cheaper next year, and still cheaper the year after. Buffett experienced value traps firsthand with Berkshire’s textile business. On the other hand, real estate brokers are cheap based on short term expectations, but will, he believes, recover and grow once again. It is often unclear which group cheap stocks fall into. The ability to properly discern is indeed the hallmark of successful investors.