It’s not the first time, and will certainly not be the last time, markets are shaken up by a financial crisis or confronted with a potentially prolonged period of stagnation in the stock market, like we’ve experienced since 2008. During the seventeen-year period between 1965 to 1981, the Dow Jones industrial average went exactly nowhere. The DJIA stood at 874 at the beginning of ‘65 and 875 by the end of ’81.
One could easily assume that the same applied to GDP and company growth. However, during those seventeen years, the size of the U.S. economy grew fivefold and Fortune 500 companies grew sales by even more than that. What you need to remember is that investing is basically laying money out now to get more money back at a later time. There are really only two questions: One is how much you’re going to get back, and the other is when. A stock market can go nowhere, but that doesn’t mean there isn’t opportunity to be found in individual equities.
SA value investors like DVK, 5+ and Chuck Carnevale are experts in detailing proper methods of assessing potential investments both from a valuation side and a technical viewpoint in their easy-to-read articles. As you may have noticed from my earlier pieces, I unknowingly found myself using these same methods before joining SA. Carnevale wrote a great piece on the US economy recently. After reading some of the comments on the article, I realized that sometimes the very manner in which you present a case can be more powerful than the argument itself, either working for or against you.
It reminded me of Warren Buffett's speech in Sun Valley in 1999, and a particular statement from Alice Schroeder, writer of Buffett’s biography, The Snowball, on his personality: “Among the many lessons, some of the best comes simply from observing him. Here is the first: humility disarms,'' says Schroeder. I then realized it may prove useful to go over a few of Buffett's quotes and some of Berkshire Hathaway's (BRK.A,BRK.B) top holdings in order for myself and similar minded investors to stay on the straight and narrow path of value investing.
Let’s have a look at some of my favorite quotes and holdings to see if they provide some clear-cut advice and vision on how to position one's self in relation to the stock market and how to formulate an investment approach designed to navigate through near-term headwinds in the market in order to take advantage of opportunities and to achieve long-term profits:
"You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing."
"You only have to do a very few things right in your life so long as you don’t do too many things wrong."
"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well."
"If a business does well, the stock eventually follows."
"A public-opinion poll is no substitute for thought."
"I don’t look to jump over 7-foot bars; I look around for 1-foot bars that I can step over."
"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."
"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."
"Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years."
"Our favorite holding period is 'forever.'"
"Price is what you pay. Value is what you get."
"Risk comes from not knowing what you’re doing."
"Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1."
"The investor of today does not profit from yesterday’s growth."
"In the business world, the rear-view mirror is always clearer than the windshield."
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid."
"There are all kinds of businesses that Charlie [Munger] and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do."
"There seems to be some perverse human characteristic that likes to make easy things difficult."
"Time is the friend of the wonderful company, the enemy of the mediocre."
"Why not invest your assets in the companies you really like? As Mae West said, 'Too much of a good thing can be wonderful.'"
"Wide diversification is only required when investors do not understand what they are doing."
"We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely."
"We enjoy the process far more than the proceeds."
"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
The carpenter teaches: "measure twice, cut once." There is a concept that cream always rises to the top, but does it? We all need a helping hand once in a while. Just the right touch at the right time, is sometimes all one needs to get where you need to go in this life. Great role models can help you do that.
Warren Buffett only wants companies that are already succeeding, companies that have been tested in the real world. Good balance sheets and an attractive entry price. He likes what he considers to be a sure thing.
We have all heard the line: “Never fix a problem that doesn’t need fixing.” Warren Buffett doesn’t trade in the typical sense; he looks for opportunities, and when he finally pulls the trigger, he always gives his investments time to work out. The key is always to try to get the initial investment right. If you don’t get the initial investment right, you always have a problem down the road. If you can get it right, and Buffett and Munger are very good at that, then time will give you the expected profits.
As of June 30, 2011, funds at Warren Buffett's Berkshire Hathaway (BRK.A) were valued at $52.36 billion USD. During the quarter, Berkshire had 27 total positions: Coca-Cola (KO), Wells Fargo (WFC), American Express (AXP), Procter & Gamble (PG), Kraft Foods (KFT), Johnson & Johnson (JNJ), ConocoPhillips (COP), Wal-Mart Stores (WMT), USB (USB), Moody's (MCO), Washington Post Co. (WPO), M&T Bank (MTB), Costco (COST), USG Corp (USG), Torchmark (TMK), Sony (SNY), General Electric (GE), MasterCard (MA), United Parcel Service (UPS), Verisk Analytics (VRSK), GlaxoSmithKline (GSK), Dollar General (DG), Bank of New York Mellon (BK), Exxon Mobil (XOM), Ingersoll-Rand (IR), Gannett Co. (GCI) and Comdisco Holding (CDCO.PK).
Let's take a closer look at BRK's holdings in order to find distinguishing features that can be seen for the portfolio as a whole. Investing in a portfolio that is somewhat contrarian is a basic prerequisite of Buffett’s philosophy. You essentially project that holdings will generate higher future returns than in recent years. Analyzing the portfolio shows it has delivered a relatively stable level of average returns and a stable level of risk, even during the volatile market conditions of the last few years.
There are a couple of underlying reasons. The first has to do with Beta. Beta measures the degree to which the portfolio tends to respond to the broader market. If you mix high- and low-Beta stocks, you will get a higher level of return relative to your risk.
The second is that the majority of BRK’s holdings provide a stable and growing dividend income stream to the portfolio. If you take the annual payout of BRK’s top 10 holdings, owning one share in each for the 5-year period between 2006 and 2011, you will find an increase of the combined annual dividend payout from $10 to approximately $13.25 now, even though the bank holdings decreased dividend payout due to the crisis and some other holdings kept their payouts stable since 2008-2009.
Another important aspect in trying to obtain above-average returns while maintaining a stable level of risk is entry point. Regarding valuation, there are a lot of easy-to-use tools available nowadays to determine fair valuation. I always try to reiterate the importance of underlying earnings (growth), so in a fairly valued situation, a growth stock's price-to-earnings ratio should equal the percentage of the growth rate of its company's earnings per share.
On the subject of strategic asset allocation, the BRK portfolio shows the benefit of striving to build substantial concentrations in individual equities while still exploiting the effects of proper diversification. You should try to focus on getting good diversification without simply buying some of everything! You can even do this while still focusing on dividend (growth) companies, as the BRK example clearly shows. Something several SA-authors have discussed at length in analyzing the range of diversification recommended in MPT (Modern Portfolio Theory). Warren Buffett summarized it best: “Wide diversification is only required when investors do not understand what they’re doing.”
Disclosure: I am long BRK.B, JNJ, XOM.