Buffett Bashing in Perspective
(March 10, 2005)
Please note that we switched to a neutral position from a 100% long position in our DJIA Timing System on the morning of January 12th at DJIA 10,530. No new signals as of now. Good news: My partner, Rex Hui, has come back from Hong Kong - therefore, our team is now 100% again and we will be fully dedicated to continue to improve our website over the upcoming months. We have, however, decided to postpone the unveiling of the DJIA Timing System section as there are no new signals as of now - we will seek to unveil the DJIA Timing System section once we have a new signal.
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Dear Subscribers and Readers,
It has been more than two weeks since we started conducting a buy-sell-or-hold poll about Fannie Mae (FNM). I have also subsequently wrote a short commentary on the stock, and while I am not a current fan of Fannie Mae by any means, I agreed that it may start to be attractive when/if the stock gets to the $45 to $50 price level (which will equal the October 1998 lows) - barring any further significant bad news. Since then, there has been more bad news, but I am still sticking to my views. Preliminary results are as follows: So far, we have only gotten four votes with two voting "sell," one voting "buy," and one voting "hold." Of course, this is not a statistically significant sample by any means so I am encouraging all my readers to vote to express their views on Fannie Mae! You're also welcomed to send me your views and opinions about the company, especially if you happened to disagree with my stance!
With the publication of the Berkshire Hathaway's annual report last Saturday morning, it is time to engage in one of the favorite "sports" among stock market writers nowadays - the sport of Buffett-bashing. Of course, efficient markets believers aside, I never like to bash anyone when it comes to the stock market, especially since the markets can really (and do) change on a dime. That being said, the analysts are again enjoying considerable clout this year, as Berkshire Hathaway again underperformed the S&P 500 (only by 0.4%, though) even though Berkshire took considerable hits (which totaled $1.25 billion, to be exact) from the four hurricanes that touched down in Florida last year. If it were not for the hurricanes, then the per-share increase in Berkshire Hathaway would have been over 12%. But apparently, this is not important to the writers who are criticizing both Buffett and Berkshire Hathaway.
Take, for example, the Forbes article asking whether "the Oracle of Omaha [is] losing his touch?" Of course, the author does praise Buffett for his long-term batting average, but what about this latest "Sophisticated Investor" article from Mr. Thomas Kostigen of Marketwatch.com? Obviously, he has a bone to pick with Buffett, as can be seen from a previous article that he wrote last year as well. In those articles, Mr. Kostigen chided Buffett for having a substantial amount of Berkshire's net worth in cash, and questioned Buffett's timing in 1999 for not investing in technology - arguing that if we have experience a "new wave" of technological improvements once again, Buffett "could drown . this time." The article that Mr. Kostigen wrote this time last year was downright nasty - as evident by the title: "Emperor Buffett has no clothes."
I am tempted to write a nasty email to the author for his arrogance, but let me quote you a few sentences from his article and perhaps you can make up your own minds:
Last year, his investment vehicle Berkshire underperformed the Standard & Poor's 500 Index by nearly 8 percentage points. Some $36 billion of his holdings are in cash, or cash equivalents. He sidestepped the dot.com bubble (and all those gains too). He barely participates in the technology sector (besides a reported throw-away personal ownership of 100 shares of Microsoft). And his biggest claim to fame is: buy and hold, otherwise known as value investing.
Any chimp can buy and hold an investment. As any money manager will tell you, the art to managing money is in the sale. But Buffett hasn't sold well either, as he admitted in his most recent shareholder letter: "We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses -- all of which had good gains in intrinsic value last year -- but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I."
These too are different times, different from the 1960s and 1970s when Buffett's buy-and-hold strategy was "ahead of its time." Now, international markets can be accessed through cutting-edge trading techniques to acquire positions in companies that may be better performers than those here in the U.S.
Shouldn't sophisticated investors be paying a money manager to utilize the best the securities markets have to offer? Shouldn't that include customized securities, innovative structures, facile trading, deep research and dead-on forecasting? Shouldn't these be the tools of the trade for "the best money manager in the world?"
How embarrassing to underperform the S&P in today's day and age. But maybe that's the problem; Buffett doesn't look at the capital markets as today's day and age. He invests for the long-term -- too long, in my opinion.
Okay, I could go on about this all day, but I won't. I will only say this: These same arguments were made as recently as 1999 and 2000. And look what happened to those "investors" and traders who made them. It is rare for a money manager such as Buffett to admit his mistakes in such a public forum. Moreover, the notion of "buy-and-hold" was as "popular" today as the 1920s and the 1960s, at the heights of those respective bull markets. And remember the Nifty Fifty, one-decision, buy-and-hold forever stocks in the May 1970 to December 1972 rally - when these "great growth stocks" were bought irrespective of valuations? Following is the action of six well-known Nifty Fifty stocks from that era and their aftermaths:
These were, of course, great companies, but valuations still count, folks. And people who forgot that lesson during the 1990s found out the hard away again during the 2000 to 2002 deflation of the Great Bubble. Ironically, however, investors who actually bought and held these stocks until today actually did quite well, but let me ask you this: How many people do you know who actually bought one of the above companies in the early 1970s and held until today? That number in the entire United States is probably less than a thousand, even as a great many times that number of "investors" bought into the Nifty Fifty stocks during the early 1970s. Buy-and-hold is definitely not a profitable strategy at all times, but when this strategy is utilized wisely and at the right time (which Buffett often has in his 50-year investing career), it can be a very powerful strategy indeed. Finally, in today's day and age, investing for the long-term is even more relevant - as most of us will eventually be living significantly longer than even the same members of society twenty years ago. For most people, daytrading or speculation will get them to the poor house (and this is speaking from personal experience) - especially in an overvalued market such as what we have today. That being said, however, didn't Buffett put over $8 billion in hugely undervalued junk bonds in 2002 and didn't he sell them at a great profit in 2003? And didn't he also make a one-year $800 million to Williams Company in the same year - charging an interest rate of 30%?
A much better written article on Warren Buffett is an article from Mr. Bill Mann on the Motley Fool (I highly recommend novice investors to read this website and to maybe even subscribe to one of their publications - note that I have no relationship with the Motley Fool) - which actually invites critical thinking (instead of promoting nastiness like the Marketwatch.com article) from his readers. Another great article (and accurate) can be found from the guys at TradingMarkets.com.
In light of all the things that we have gone through about Berkshire sitting on too much cash, it is probably instructive to see just how much cash Berkshire is sitting on - compared to what Buffett and Munger has been doing in the past ten years or so. Following is a chart depicting the amount of cash (and equivalents), fixed income securities and equities as a percentage of shareholders' equity for Berkshire Hathaway (not including MidAmerican) over the period from 1994 to 2004:
At just slightly over 46% of shareholders' equity, the amount of cash that Berkshire Hathaway is holding today is staggering and most probably unprecedented (for readers who think otherwise, please let me know). This could only be likened to the year 1969 when Buffett disbanded his investment partnership and returned the money to all his shareholders, claiming a lack of values and opportunities in the stock market. There is one important thing I would like to mention and I would let my readers decide: Either the Oracle of Omaha is losing his touch or we are going to have one hell of a decline again once this cyclical bull market tops out (which this author believes will happen sometime this year).
As a percentage of total shareholders' equity, Berkshire has also been moving out of bonds and into cash - suggesting that there are now hardly any values to be found in any markets (you are encouraged to read the Bloomberg article that I posted today in our discussion forum regarding emerging markets bonds - the appetite for risk-taking is as great as ever judging by the performance of international stock and bond markets over the last year or so) - domestic, international, equity, or fixed income. If Buffett is proven correct, then we may very well experience a period of time when both equity and bond prices will decline greatly - something that has not happened since the late 1960s to 1970s.
In terms of acquisitions, the only significant acquisition that Buffett outlined in his 2004 letter was the completion of the acquisition by Clayton Homes (a producer and retailer of manufactured homes which Buffett bought in August 2003) of Oakwood Homes - thus making Clayton the industry's largest producer and retailer of manufactured homes today.
Sometimes, however, the best way to learn is to learn from one's mistakes. On the write-off by MidAmerican of a major investment in a zinc recovery project on page 5: "Our failure here illustrates the importance of a guideline - stay with simple propositions - that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for - if you'll excuse an oxymoron - mono-linked chains."
A case in point: That is why I have always emphasized in the past that in order to even try to call a top in this cyclical bull market, we will need to see virtually all indicators screaming at us before I am willing to call a top. At this point, it is still not obvious to me yet. Here is something that I just thought up: Who wants to bet that before this cyclical bull market is over, newsletter and stock market writers will be screaming at Buffett and Munger to distribute their cash holdings in the form of dividends to their investors - since the former has lost their touch and are missing out in this new bull market (which may turn out to be a final blow-off not unsimilar to the October 1999 to March 2000 rally)? If this truly does happen, then it will be one of the greatest sell signals ever - right up there with the demise of Julian Robertson and the Tiger Fund in March 2000.
Conclusion: I do not agree with the Buffett bashers. On the contrary, I believe that one can learn a lot from Buffett by studying his past transactions and annual reports. For example, why did he purchase Freddie Mac in 1988 (which is not as highly publicized as his Coke purchase in the same year) and why did he subsequently double those holdings in 1992? Why did he liquidate all of it by the late 1990s? Also, despite the value that some people see in the shares of Fannie Mae today, why isn't Buffett buying either Fannie Mae or Freddie Mac? Going forward, I intend to spend more time studying both Warren Buffett and the history of Berkshire Hathaway (and the GSEs since I believe that they will provide good buying opportunities sometime in the future), since I believe doing so will provide an invaluable experience to both my investing prowess and to my readers as we try to continue to navigate the tough times that will surely be ahead of us. I invite our readers to take part and share your experiences as we continue this long journey ahead.
Please participate in our new poll: Is Berkshire Hathaway a buy, sell, or hold? Thank you for participating!
Henry K. To, CFA