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Lessons from Buffett
This article appeared in the June 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Michael Kemp joined Bono and Bill Gates at the Berkshire AGM.
By Michael Kemp, author
Long hailed as "the Woodstock for Investors", Berkshire Hathaway’s annual general meeting is the must-attend event for value investors from around the world. I was fortunate enough to make the pilgrimage to Omaha to attend this year.
Much of what Berkshire’s 81-year-old CEO, Warren Buffett, and his able lieutenant, 88-year-old Charlie Munger, said on that first Saturday in May, I had heard before. If you’ve read the books and the chairman’s letters, and watched the many Fox and CNBC interviews and documentaries, you would recognise many of the pithy one-liners from Buffett and Munger. But when you are in their presence, the words carry a weight no book or TV interview can possibly convey.
Like no other AGM
Let’s get things straight from the start: there is nothing typical about this company, its AGM or its CEO. This is why:
- With a market capitalisation of $203 billion, Berkshire is nearly twice the size of BHP Billiton.
- The AGM is held at the largest entertainment stadium in Omaha, necessary because 35,000 people attend.
- Bono, the lead singer of rock band U2, and Bill Gates, founder of Microsoft, were there; not the faces I’m used to seeing at a typical AGM.
- The meeting kicked off with a series of short film clips, led by a cartoon and then a comedy skit both featuring Buffett.
- Buffett is currently the world’s third wealthiest man. Not bad, because he’s already given away 30 per cent of his money to charity.
- Buffett chaired the meeting. Providing back up was Munger. Their six-hour stage performance dripped with investment wisdom. But the two also know how to ham it up, and occasionally it took on the flavour of "Laurel and Hardy come to Wall Street".
Buffett - the investor
Since Buffett was first appointed to the board in 1965, the per-share book value of Berkshire has grown by 513,000 per cent. Over the past 47 years the company has achieved an average return of 19.8 per cent per annum. That’s a further 10.6 per cent on top of the 9.2 per cent the S&P 500 index in the US has delivered.
What makes this achievement so remarkable is Buffett never started a business of his own. He’s never built an IBM, an Apple or a Microsoft from scratch. Describing himself as an asset allocator, he has achieved this success from stock-picking and purchasing entire businesses at attractive prices. Given this depth of investment wisdom, let’s see what the world’s most successful investor has to say about the current investment climate.
Buffett on macro-economics
Make no mistake, while Berkshire is worth $200 billion you won’t find a single economist in the place. Buffett can’t see the point. The following response was to a question from the audience on how the economic outlook is currently influencing his investment decisions: "In 53 years I don’t think we have ever had a situation where we have bought a stock based on macro affairs."
And in an effort to strengthen his claim, Buffett went on to say he bought his first shares in June 1942 when he was 11 years old, and "at that time America was losing the war".
Although Buffett does not rely on reading the economic tea leaves, he commented in Berkshire’s recent annual report on the present state of the US economy. Acknowledging Berkshire is a widely diversified company, he said: "When you are looking at Berkshire you are looking across corporate America. The steady and substantial comeback in the US economy since mid-2009 is clear from the earnings shown at the front [of the annual report].” He also made a comment in relation to Berkshire’s home building business, Clayton Homes: "Though housing-related businesses remain in the emergency room, most other businesses have left the hospital with their heath fully restored."
On investment principles
The take-home message of the AGM was the unwavering nature of Buffett’s investment principles. Sure I had heard most of them before, but that’s exactly the point: his message doesn’t change with the market cycle. This is in stark contrast to most sharemarket participants. They are influenced by prevailing sentiment, and market commentators are often quick to criticise the principles that have served Buffett so well.
Buffett on gold
Buffett is clearly no gold bug. He believes gold "has two significant shortcomings, being neither of much use nor procreative". He describes gold as being popular at times when fear is the predominant sentiment. "What motivates most gold purchasers," he says, "is their belief that the ranks of the fearful will grow."
Over recent years "the rising price has, on its own, generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As bandwagon investors join any party, they create their own truth - for a while."
Buffett on long-term investing
Buffett describes three types of investments:
- Interest-bearing investments denominated in a given currency - bank deposits, bonds, mortgages, etc.
- Assets that will never produce anything (e.g. gold).
- Productive assets - businesses, farms, real estate, etc.
Buffett is an investor, so he favours category 3. He sees category 2 as a waste of time and category 1 as a necessary parking spot for money yet to be invested. At present Berkshire has $33 billion parked in cash and cash equivalents. To take advantage of opportunities as they arise, he prefers not to let this cash balance fall below $20 billion.
On a suitable time horizon for investing, Buffett says: "I try to look out 10 or 20 years when making an acquisition, but sometimes my eyesight has been poor. Charlie’s has been better; he voted no more than 'present' on several of my errant purchases."
Buffett on dividends
Because Berkshire has not paid a dividend since 1967, the uninitiated might argue it is a non- income-producing asset. But to do so fails to recognise the company has, for many years, been reinvesting retained profits at high rates of return. Buffett has always felt the money was better in his hands than those of the shareholders. Hence his now famous comment about that single US10-cent dividend Berkshire paid back in 1967: "I must have been in the bathroom when the dividend was declared".
Despite Buffett’s four-decade stance on retaining and reinvesting all profits, he still had to field a question from one concerned shareholder - she wanted to know why, with more than $30 billion in the bank and a share price of $120,000, Berkshire was not prepared to pay a dividend. Buffett politely answered as if it was the first time the issue had been raised. He explained that the share price was $120,000 because of years of profit retention and reinvestment. If she wanted a dividend, she was free to sell some shares, he said.
On the US housing bubble
Buffett’s take on the depressed US housing market is simple. He sees it all boiling down to supply and demand. Leading up to the 2007 subprime meltdown, more houses were being built in the US than there were people to live in them. Now, as fewer houses are being built, the formation of new households is soaking up the excess supply. "In 2007 the bubble burst. We are now in the fifth year of a cure that, though long and painful, is sure to succeed. Today, household formations are consistently exceeding housing starts," he said.
On US and European banks
Buffett says: "US banks are far better than a few years ago. They’ve taken most of their abnormal losses. They’ve buttressed their capital. They’ve got liquidity coming out of their ears." And this comment regarding one of Berkshire’s substantial bank holdings: "Wells Fargo is prospering. Its earnings are strong, its assets solid and its capital at record levels."
But on European banks he says: "The European banks were gasping for air recently until the European Central Bank opened up its wallet." However, Buffett remains concerned about European banks because "they get a higher proportion of their funding from non-deposit sources."
Berkshire Hathaway as an investment
Berkshire Hathaway owns 79 companies outright and has a diversified holding of publicly listed companies. Its largest shareholdings, in order of value, are Coca-Cola (it holds 8.8 per cent of total shares), IBM (5.5 per cent), Wells Fargo (7.65 per cent) and American Express (13 per cent).
Adding to the attraction of Berkshire are the combined factors of the Australian dollar being historically strong and Berkshire shares, as measured on a price-to-book basis, are cheap. Don’t worry that the class A shares (BRKA) are trading at $120,000. If you have less cash to splash, the class B shares are trading at close to $80.
Buffett on Berkshire’s current price
Of Berkshire’s intrinsic value, Buffett say: "We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it; per-share book value." Buffett believes for most companies this yardstick is meaningless, but at Berkshire it roughly tracks business value.
Last September Buffett put his money where his mouth is. Berkshire announced it would buy back its own shares at any price up to 110 per cent book value. Then it meant any price up to $110,000. This was only the second buyback in the company’s history. "We were in the market for only a few days - buying $67 million in stock - before the price advanced beyond our limit."
Buffett describes the decision to buy Berkshire shares then as "like shooting fish in a barrel, after the barrel had been drained and the fish had quit flopping." In typical Buffett style, he wanted those selling to be fully informed of what they were doing. "At the limit price of 110 per cent of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and cheaper we buy, the greater the gain for continuing shareholders."
The definitive summary on price: if the world’s greatest stock-picker thinks Berkshire is cheap - who am I to argue?
Recognising his mortality, Buffett has, for six years now, been donating his Berkshire shares. In 2006 he had 500,000 Class A shares. At current share prices that’s $60 billion. At present he holds 350,000 shares (and falling). That’s a net worth of $42 billion - still not too bad.
About the author
Michael Kemp has had a long career in Australian financial markets. Following the release of his first book, Creating Real Wealth, in 2010, he now works as a freelance financial writer.
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