“If past history was all there was to the game, the richest people would be librarians.”
— Warren Buffett
Warren Buffett is no librarian, but he is considered to be the greatest investor of all time. He made his fortune the old-fashioned way — he worked for it. Unfortunately, Berkshire Hathaway’s recent 9.6 percent loss in book value represents the biggest decline since he took over the company in 1965. Berkshire’s stock fell 32 percent in 2008. It dropped a further 19 percent in 2009.
Despite 2008’s setback, the overall investment gain of Berkshire from 1964-2008 was 362,319 percent; compounded annual gain was 20.3 percent. This performance was 90 times greater than the S&P 500 with dividends included.
Buffett in his annual letter, which some look at as a financial bible, shared his views on the economy and financial-system stresses.
Economic outlook
Buffett believes that massive government intervention in the economy is a necessary evil:
“This debilitating spiral has spurred our government to take massive action,” he wrote. “In poker terms, the Treasury and the Fed have gone ‘all in.’ Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.”
Investment outlook
Buffett draws a distinction between his perceptions that “the economy will be in shambles throughout 2009 — and, for that matter, probably, well beyond” and his outlook for the stock market. Simply stated, he feels that nobody can predict whether the market will rise or fall.
In a nutshell, Buffett and his partner Charlie Munger live by this credo: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Buffett’s willingness to invest even during bear markets reflects his belief in the American system.
“Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.”
Buffett feels that holding cash is a terrible long-term asset because it pays virtually nothing and is certain to depreciate in value.
Buffett cherishes the teachings of American economist Ben Graham, who said, “Price is what you pay; value is what you get.”
Unlike most of us, Buffett does not mind stock prices on his investments declining as long as he has available funds to purchase positions when the markets tank. He believes that currently the investment world has overpriced risk.
Buffett and Munger possess four goals:
Maintain Berkshire’s Gibraltar-like financial position, with huge amounts of excess liquidity.
Widen “moats” around operating businesses that give them durable competitive advantages. (This means to erect barriers to prevent to prevent entry by competitors, such as with patents or copyrights or by establishing brand recognition through massive advertising campaigns)
Acquire and develop new and varied streams of earnings.
Expand and nurture a cadre of outstanding operating managers.
Buffett’s 2008 mistakes
Buffett confessed that he made some dumb mistakes in 2008; specifically purchasing ConocoPhillips (COP) stock when oil and gas prices were close to their top. Buffett laughingly used the tennis analogy of “unforced error” to judge his COP acquisition. He committed errors of omission such as “sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.”
Buffett’s Waterloo?
Berkshire Hathaway stock has declined in part over Buffett’s revelation that his large derivative investments caused multibillion-dollar markdowns. He teasingly used this sex analogy to highlight derivatives’ dangers. “It is not just whom you sleep with, but also whom they sleep with.”
Derivatives act like financial venereal diseases in that profit and loss manifest over long time periods and the fallout from deteriorating creditworthiness of counterparties can spread without limits. Despite the investment dangers, Buffett defended his derivative bet:
“I believe each contract we own was mispriced at inceptions, sometimes dramatically so. I both initiated these positions and monitor them, a set of responsibilities consistent with my belief that the CEO must be the Chief Risk Officer as well.”
Americans are very fortunate that in this fight for our lives, we have Buffett is our corner. We need his sage advice to stanch our financial bleeding.
Originally published in the Sarasota Herald-Tribune
