Very good new white paper from Tweedy Browne. In our opinion one of the top five reads is another Tweedy Browne white paper titled What Has Worked Fund In Investing, this new white paper is a close second. Check the full thing out below.

Investing for Higher After-Tax Returns:

Lessons for Tax-Paying Investors from Warren Buffett, Index Funds,
the Best-Performing Stocks over an 18-year Period, and Our Own Experience

TABLE OF CONTENTS

Page Introduction ………………………………………………………………………….. 1

Pre-tax and After-tax Investment Return Arithmetic:
How delaying taxes as long as possible may dramatically increase
your wealth at any given pre-tax rate of return ………………………………… 5

Why Do Professional Money Managers And Investment Analysts
Engage in So Much Buying And Selling? ………………………………………… 11

Quantitative and Qualitative Examination of three of Warren Buffett’s long-term Winners:

GEICO, The Washington Post Company and The Coca Cola Company and two apparent Losers (at least so far):

World Book, Inc. and Berkshire Hathaway’s Shoe Group …………………….. 12

Connoisseurs of Competitive Advantage:
Mimicking the Master: Buffett 101……………………………………………….. 22

Characteristics of the Best and Worst Performing Stocks
in the S&P 500 Index over an 18-Year Period ………………………………….. 26

Earnings Per Share Growth over the 18-Year,
December 31, 1980 – December 31, 1998 Period
for Companies that were in the S&P 500 as of December 31, 1980 …………… 30

Perfect Together: High Returns from Stocks
that Combine Value and Growth; Buy Cheap and Keep ……………………….. 31

The Intrinsic Value of a Growing Business:
How Warren Buffett Values Businesses………………………………………….. 31

When to Sell: A Framework for Tax-Paying Investors;
Thinking and Acting Like an Owner of a Business……………………………… 37

Predicting the Future of Businesses ………………………………………………… 39 Diversification and the Mathematical Magic of Skewness ………………………… 43 Just in case ……………………………………………………………………………. 47 An example of skewness and unplanned, accidental concentration ……………… 48 Our Advice to You……………………………………………………………………. 48

APPENDIX A

APPENDIX B APPENDIX C

APPENDIX D

Page

After-Tax Return on Stocks assuming 20% and 15%
Yearly Returns and Various Turnover Rates …………… 50

State Income Tax Rates as of 12/31/98 …………………….. 62 17 Standard Earnings Outlook/Value Questions

Checklist …………………………………………………… 63

Buffett 101: Questions/Checklist Concerning Assessing a Company’s Growth Prospects, Competitive Position
and Economics…………………………………………….. 65

INVESTING FOR HIGHER AFTER-TAX RETURNS:
Lessons for Tax-paying Investors from Warren Buffett,
Index Funds, the Best Performing Stocks over an 18-year Period, and Our Own Experience

INTRODUCTION

This report will describe what we have learned about investing for higher after-tax returns, and our investment strategy for tax-paying investors. The Managing Directors of Tweedy, Browne Company LLC have become increasingly aware of taxes over the last ten years as their own wealth and clients’ wealth has increased. We presently have nearly our entire liquid net worths, approximately $400 million of our own money that has been accumulated over the years, invested in portfolios that are jointly owned with clients, including Tweedy, Browne Global Value Fund and Tweedy, Browne American Value Fund, and in separate portfolios whose equity holdings are similar to the holdings of clients’ portfolios.

Nearly all of our own money, and probably more than 50% of the money that we manage for clients, is subject to income taxes and capital gains taxes. Capital gains taxes only occur when a stock is sold at a gain above cost, and, hence, are somewhat unique in that they are elective: You can decide if and when you want to sell a stock at a gain, and thereby incur capital gains taxes. Alternatively, you can decide to not sell a stock at a gain and, therefore, not pay capital gains taxes. It has been said that “the only sure thing is death and taxes”, but the second part of this statement does not hold true for capital gains taxes.

Our thinking and exploration of the impact and importance of taxes on investment returns has been aided greatly by Warren Buffett, one of the world’s most successful investors, and by John Bogle, former Senior Chairman and Founder of The Vanguard Group of mutual funds. Warren Buffett has at times invested nearly 40% of his net worth in one stock, and owns operating businesses through his holding company, Berkshire Hathaway. Warren Buffett is the epitome of an active investor. John Bogle, on the other hand, advocates passive, do-nothing investing in index funds, which do not have portfolio managers and investment analysts engaged in analyzing individual stocks, and attempting to beat the market. Index funds that mimic the investment performance of the

Standard & Poor’s 500 Index simply buy each and every one of the 500 stocks that are in the S&P 500, and then continue to hold them. Mr. Buffett and Mr. Bogle seem bi-polar in investment approach, but they are completely joined in understanding and advocating the huge advantage of avoidance and deferral of taxes over very long periods of time. Mr. Bogle calls it, “Buy right and hold tight.”

At Tweedy, Browne, we consider index funds to be our biggest, toughest long-term competitor. The S&P 500 outperformed 91% of all surviving equity mutual funds over the

December 31, 1981 – December 31, 1997 16-year period.* Index funds that mimic the S&P 500 probably beat close to 91% of equity mutual funds over this period. Anyone in the investment management business who does not respect the challenge of low-fee index funds that rarely sell stocks and, therefore, rarely realize capital gains, is, as psychologists would say, in denial.

Fortunately, the investment approach that our firm has practiced for more than 25 years has served us and our clients well. We have to admit that we might be a little bit tempted to at least consider investing some of our own money and clients’ money in an index fund if the valuation wasn’t so high: The S&P 500 is now about 35x reported earnings, with no downward adjustment of these reported earnings figures for “one-time, non-recurring writedowns and special charges” that, in fact, seem to be very recurring expenses that would reduce reported earnings if the companies’ accounting practices were more conservative. The S&P 500’s earnings are also not adjusted downward for the hidden expense of large stock options. In addition, the S&P 500 is priced at over 6x tangible book value. Both the price-to-earnings ratio, 35x, and the price-to-book value ratio, 6x, are all-time high valuations. In 1980, the S&P 500 was selling at 9.2x earnings. It seems very unlikely to us that future gains for the S&P 500 from a starting point of 35x earnings in 1999 will come at all close to generating the 16.94% per year gains that occurred over the 18-year period from December 31, 1980 through December 31, 1998 from a starting point in 1980 of 9.2x earnings.

At Tweedy, Browne, we are well aware that our investment management services are not the only show in town, and that we, the Managing Directors, and clients of the firm always have the alternative of investing in a very low-fee index fund that avoids taxes – because stocks are seldom sold. We do not know for sure if the investment approach that we practice will add value above index returns in the future, as it has in the past, but we are hopeful. We only really have control over investment strategy and its implementation, and the future returns will be substantially determined by what other human beings will pay in the future for stocks that we own. We do know for sure that we can invest our own money and clients’ money in stocks that are significantly cheaper in relation to earnings, book

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