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Summary

  • Warren Buffett is sitting on his largest cash pile, ever. Warren has a very big chest, war chest that is.
  • Warren chooses cash over bonds for the obvious reason that cash is liquid and available. It's dry power that he can quickly fire.
  • What can we learn from Warren Buffett and his Berkshire Hathaway Funds sitting on cash for a couple of years, not finding much that is investment-worthy?
  • Warren Buffett looks at cash differently than would you and I; to Mr. Buffett cash is a call option that can be priced.

Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is sitting on $50 billion, which is a lot of cash to say the least. That money pile could buy a lot of businesses. In my home country he could go out and purchase a few really good companies, outright. He could purchase my beloved Tim Hortons (THI) several times over. But he's not buying much of anything. He is not finding much value in the market. He perhaps has not felt there has been much value in this market for a few years running.

Articles in 2012 were discussing the massive cash pile of Berkshire. It stood at $41 billion or so. Mr. Buffett has been waiting and adding to a cash reserve that is earning very little with interest rates being suppressed at very, very low levels. Government agencies have been suppressing rates in the hope that investors seek higher returning assets such as stocks, but Warren ain't biting. And he's willing to provide sub-market returns as the short term cost of holding this amount of cash. As many of us know, BRK has not beat the markets over the last 5 years, and if one is not fully invested in the market (NYSEARCA:SPY) they stand the chance of underperforming that market due to the under performance of asset classes such as cash and bonds.

And Warren has a much more sophisticated take on cash than what appears on the folksy surface.

This according to Alice Schroeder, his official biographer. She wrote Snowball: Warren Buffett and the Business of Life.

Mr. Buffett, the world's most successful (and richest) value investor, is sitting on almost $41-billion (U.S.) of cash at his Berkshire Hathaway holding company, the most in a year. Partly, that heap of greenbacks is a safety blanket. But it's something more. As with most matters Buffett, the strategy is more complicated than it looks.

Ms. Schroeder argues that to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates...

He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.

She states Warren weighs the risks and returns on that option and does the math. It is statistically-based and sound, of course, we are talking about Warren Buffett here. When talking to his investors and the general investing populace he will simplify the message and send the message that cash provides opportunities to buy stuff when the opportunity presents itself.

Warren must not see any opportunity these days, and that is telling. I am of the same mind to a degree and recently wrote the article "There's No Money To Be Made From Here, Maybe".

There are times when the money we invest presents the likelihood of very low returns. This from that article. As we all know all too well, we entered a long term secular bear market at the beginning of this century.

Any monies invested in January of 2000 in the broad market S&P 500 would have a total return of -5.3% over 5 years with dividends reinvested.

From 2000 over ten years we would see a -.99% return. From 2000 to present we have a total return of 63%, or annualized returns of 3.5%. Factor in inflation and moneychimp.com says the return would then be a compound annual growth rate of 1.17% to December of 2013. Cash (CDs) would have beaten the snot out of the stock market from that start date, with zero risk.

Now if we move back one year before the market top, we see that monies invested would still not have made any "real money." Over 5 years from 1999 a -3.1% total return. Over 10 years from 1999 a -13.1% total return.

Now I should state that I have no idea where the markets are going to go in the short to medium term, investors have periods where they will pay more and more for the earnings power of the companies or markets that they hold. But we can see the longer term trends of earnings and how those earning relate to stock prices. From here, there is the probability once again that there's not much to be made over the longer term, once the market resets.

Price to earnings ratios are high. If we use the well-respected cyclically adjust price to earnings ratio CARP we are in the nosebleed section. The CARP analysis method is based on Benjamin Graham's work, and of course Mr. Buffett's teacher and investment methods are based on the work of Mr. Graham. But even if we look at the Price to Earnings snapshot, the current PE levels, we are well above the norms and averages.

Many will then write that it's a stock picker's market, that there's value and deals to be had if you can find those needles in the haystack. Mr. Buffett of course has to play in the large cap area given the size of the Berkshire Hathaway Funds. That makes deals hard to find. Benjamin Graham was of the mind that the market is efficiently priced most of the time; and that may be a surprise to many that Mr. Graham was a proponent (perhaps one of the original believers) of efficient market theory.

I think there's as much or more to learn from Mr. Buffett's take on when to buy than how to find great companies. Much of Mr. Buffett's returns are based on buying when the overall markets are on sale, when most everything goes on sale. Not only that, BRK will use leverage and borrow funds (from its own holdings, ha) to purchase when the markets go on sale. If you look at the companies that BRK holds, the magic is in the price paid. There's no mystery to the companies that Warren purchases for shareholders. But at times he will snap up great companies when they run into trouble and are truly under appreciated, and under valued.

Benjamin Graham demonstrated in The Intelligent Investor that you can purchase a great company with great prospects; even a company that delivers on all of its potential, and still have it turn out to be a very bad investment. Mr. Graham described it as purchasing without a margin of safety. Today, Mr. Buffett is largely not finding his teacher's margin of safety. Perhaps we can go as far to suggest that even the wonderful dividend payers that BRK holds are not a good investment at today's prices.

OK, to be fair Warren is tweaking his portfolio of public holdings. Here's a wonderful update from Seeking Alpha author John Vincent on Mr. Buffett's latest portfolio allocations. Mr. Buffett has further concentrated his portfolio in just a few holdings.

For Mr. Buffett, sitting on piles of cash that is earning next to nothing is a better investment that common stocks. That should give most investors reason to pause. Should we not listen to the world's most successful investor? There were many times when the investment world has thought that Mr. Buffett had got it wrong. Mr. Buffett has always proved them wrong. It does not pay to ignore the Oracle, or count out his investment acumen. Warren Buffett is not the world's greatest stock picker, Warren Buffett is the world's greatest investor. He is the most Intelligent Investor.

If you do not have cash available you will not have the ability to buy companies when they are finally available at a reasonable or discounted price. You will be holding some wonderful companies, but perhaps you will have very small portfolio income to reinvest. It's time to listen to Mr. Buffett and Mr. Graham. In some periods we have to wait, we have to be very patient, and we to have that money available to go shopping.

Mr. Buffett is taking a prudent approach, he is selling some companies that have had a great run, perhaps companies that he thinks are overvalued. There's nothing wrong with allowing someone to pay you an inflated price for one of your holdings. If someone offered you $2 million for your $1 million home, you might just take it.

Why not just buy BRK?

And here's a crazy thought, investors have the option of buying shares of BRK. You would instantly have a cash position and managers able to turn even more of their holdings into more dry powder. You'd also be teaming up with the investor who best knows how to take advantage of market volatility and how to find those true bargains. Investors also have the option of mimicking some of Mr. Buffett's recent moves as it relates to common stocks and valuations. If we could all go back 20 years or more, we'd go back and cash in our portfolios and invest it all in Berkshire Hathaway. When will that not turn out to be a good idea? I don't know. But we should remember that Warren was taught by Benjamin Graham and Warren and Charlie and others have trained their team. You're are buying into a philosophy and a detailed strategy as much as you are buying into an individual or two.

Buying Berkshire heading into the last two major market corrections would have turned out to be a market-beating venture. I'll be back with an article that shows how you can beat or match those Berkshire returns by using the market index and using that cash option. It's the strategy that is important.

Berkshire Hathaway's greatest outperformance relative to the markets has come when the stock markets have experienced down years.

And as always, we'll return to the wisdom of Benjamin Graham. If you are dollar cost averaging (with new monies) then you are practicing the only reliable form of market timing, and Ben would have no problem with you buying at these levels on a regular schedule. You will get your chance to buy on the cheap. Though it is my guess that in this situation when perhaps nothing looks attractive by the way of stocks and bonds, Mr. Graham would suggest a mix of 50% stocks to 50% bonds for the defensive investor. I would invite others to weigh in on that. What would Ben do today?

These appear to be crazy times for investors, but crazy is the norm, and there can always be a new normal. Be prepared for anything and everything. And one can only be truly prepared with cash.

Happy investing, and be careful out there. And of course, always know your risk tolerance level.

Disclosure: The author is long VIG, SPY, EWC, EFA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.ank (formerly ING Direct). The Tangerine Investment Portfolios offer complete, low-fee index-based portfolios to Canadians. Dale's commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process

Source: Warren Buffett Hates Bonds, Loves Cash