What Can We Learn from Buffett's Recent Put Sales?

Includes: BRK.A, BRK.B
by: Michael Riley

The most recent Morningstar discusses the huge long-term domestic equity put sales by Berkshire Hathaway (NYSE:BRK.A) (http://www.morningstar.com) and their foreign counterparts. Setting aside the merits of various option models for dissecting this position, there are often more important and effective ways to view risk-vs.-reward and to determine “fair value.” Our partner, Danny Mintz, has an MIT background and has based a career in trading technology, but his take is quite interesting in that he eschews mathematics, deploying fundamental analysis instead. This blend of fundamental analysis with a range of option strategies can powerfully enhance the returns of any investor’s portfolio.

Danny’s comments follow:

In extending Bill Bergman's piece, we are fortunate: over the years Warren Buffett has expressed himself so clearly and on so many occasions that we can with confidence delineate his thought processes. Buffett did not try to pick a bottom here or to time the market in any conventional sense. He never does. But we do know how he evaluates individual companies and buys their future earnings. For this bet, where he is buying the earnings of the S&P, it is the entire American economy that is relevant, given the predominant share that big business will always have here.

And what does Buffett foresee? Productivity gains for sure, since nowadays knowledge is never lost, only added to. Plus, there will be even more growth, fueled by continued population gains. Together, these trends make his puts guaranteed winners, because all he cares about is earnings.

To be sure, there are implicit assumptions that Buffett has always left unstated, such as treating the past 200 years as if they were 200 independent experiments. An argument could be made that all we have had is one two-hundred-year-long trial. In the preceding trial, when we kicked out the British, their investments all plunged to zero. And with contemporary overseas bets, there could possibly be upheaval. In any neo-colonized country there is always the risk that the population will seize its own resources and divert those resources for the benefit of the locals. However, these tumults occur so seldom, and Buffett's overseas bets are so diversified, that here, too, he sees himself on safe ground.

There are lessons here. If we start with reasonable axioms and proceed logically, we can find opportunities. That is one lesson. Heading in the other direction … we need to find all the reasons this was not a good trade. With this massive a position they must be there. The fact that this trade looks so good makes the search all the more important. It is the seductive trades that demand the most careful investigation. That is the other lesson we should take from here.